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Optimal Monetary Policy with Staggered Wage and Price Contracts

Christopher J. Erceg (), Dale W. Henderson () and Andrew T. Levin ()
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Christopher J. Erceg: National Bureau of Economic Research, Federal Reserve Board, 1050 Massachusetts Ave, Cambridge, MA 02138, USA
Dale W. Henderson: Georgetown University, General Economics, 3700 O St NW, Washington, DC 20057, USA
Andrew T. Levin: Dartmouth College, Department of Economics, 322 Rockefeller Hall, Hanover, NH 03755–3514, USA

Credit and Capital Markets, 2019, vol. 52, issue 4, 537-571

Abstract: We formulate an optimizing-agent model in which both labor and product markets exhibit monopolistic competition and staggered nominal contracts. The unconditional expectation of average household utility can be expressed in terms of the unconditional variances of the output gap, price inflation, and wage inflation. Monetary policy cannot achieve the Pareto-optimal equilibrium that would occur under completely flexible wages and prices; that is, the model exhibits a tradeoff in stabilizing the output gap, price inflation, and wage inflation. We characterize the optimal policy rule for reasonable calibrations of the model. We also find that strict price inflation targeting generates relatively large welfare losses, whereas several other simple policy rules perform nearly as well as the optimal rule.

Keywords: Monetary policy; Inflation targeting; Nominal wage and price rigidity; Staggered contracts (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:kuk:journl:v:52:y:2019:i:4:p:537-571