Real Wage Rigidities and the New Keynesian ModelOlivier Blanchard () and Jordi Gali () Journal of Money, Credit and Banking, 2007, vol. 39, issue s1, pages 35-65 Abstract: Most central banks perceive a trade-off between stabilizing inflation and stabilizing the gap between output and desired output. However, the standard new Keynesian framework implies no such trade-off. In that framework, stabilizing inflation is equivalent to stabilizing the welfare-relevant output gap. In this paper, we argue that this property of the new Keynesian framework, which we call the "divine coincidence", is due to a special feature of the model: the absence of nontrivial "real" imperfections. We focus on one such real imperfection, namely, real wage rigidities. When the baseline new Keynesian model is extended to allow for real wage rigidities, the divine coincidence disappears, and central banks indeed face a trade-off between stabilizing inflation and stabilizing the welfare-relevant output gap. We show that not only does the extended model have more realistic normative implications, but it also has appealing positive properties. In particular, it provides a natural interpretation for the dynamic inflation-unemployment relation found in the data. Copyright 2007 The Ohio State University. Downloads: (external link) Related works: Access Statistics for this article Journal of Money, Credit and Banking is edited by Pok-Sang Lam, Deborah Lucas, Masao Ogaki and Kenneth D. West More articles in Journal of Money, Credit and Banking from Blackwell Publishing |
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