Monetary policy when wages are downwardly rigid: Friedman meets Tobin

Jinill Kim and Francisco Ruge-Murcia

Journal of Economic Dynamics and Control, 2011, vol. 35, issue 12, 2064-2077

Abstract: Monetary policy in an economy with both downwardly rigid wages and a transaction motive for money demand is studied using a dynamic stochastic general equilibrium model. The two key features of the model imply that both Tobin's “inflation grease” argument and Friedman's rule are operative, and so optimal inflation may be positive or negative. The Simulated Method of Moments is used to estimate the nonlinear model based on its second-order approximation. Results indicate that the Ramsey policy that maximizes social welfare involves an average inflation rate of about 0.4% per year. In the more realistic case where a central banker follows a simple targeting policy, the optimal inflation target is about 1% per year. We view this result as providing support for the low, but strictly positive, inflation targets used in many countries.

Keywords: Downward nominal wage rigidity; Asymmetric effects of monetary policy; Optimal inflation; Nonlinear dynamics (search for similar items in EconPapers)
JEL-codes: E4 E5 (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (29)

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Related works:
Working Paper: Monetary Policy When Wages Are Downwardly Rigid: Friedman Meets Tobin (2009)
Working Paper: Monetary Policy When Wages Are Downwardly Rigid: Friedman Meets Tobin (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:35:y:2011:i:12:p:2064-2077

DOI: 10.1016/j.jedc.2011.08.002

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