Downward Nominal Wage Rigidity and the Case for Temporary Inflation in the Eurozone

Stephanie Schmitt-Grohe and Martín Uribe ()

Journal of Economic Perspectives, 2013, vol. 27, issue 3, 193-212

Abstract: Since the onset of the Great Recession in peripheral Europe, nominal hourly wages have not fallen from the high levels they had reached during the boom years -- this in spite of widespread increases in unemployment. This observation evokes a well-known narrative in which nominal downward wage rigidity is at the center of the current unemployment problem. We embed downward nominal wage rigidity into a small open economy with tradable and nontradable goods and a fixed exchange-rate regime. In this model, negative external shocks cause involuntary unemployment. We analyze a number of national and supranational policy options for alleviating the unemployment problem caused by the combination of downward nominal wage rigidity and a fixed exchange-rate regime. We argue that, in spite of the existence of a battery of domestic policies that could be effective in solving the unemployment problem, it is unlikely that a solution will come from within national borders. This leaves supranational monetary stimulus as the most compelling avenue out of the crisis. Our model predicts that full employment in peripheral Europe could be restored by raising the euro area annual rate of inflation to about 4 percent for the next five years.

JEL-codes: E24 E31 E32 E52 F33 (search for similar items in EconPapers)
Date: 2013
Note: DOI: 10.1257/jep.27.3.193
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Citations: View citations in EconPapers (86)

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