Optimal fiscal and monetary policy with costly wage bargaining

David Arseneau and Sanjay Chugh

No 893, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Costly nominal wage adjustment has received renewed attention in the design of optimal policy. In this paper, we embed costly nominal wage adjustment into the modern theory of frictional labor markets to study optimal fiscal and monetary policy. Our main result is that the optimal rate of price inflation is highly volatile over time despite the presence of sticky nominal wages. This finding contrasts with results obtained using standard sticky-wage models, which employ Walrasian labor markets at their core. The presence of shared rents associated with the formation of long-term employment relationships sets our model apart from previous work on this topic. The existence of rents implies that the optimal policy is willing to tolerate large fluctuations in real wages that would otherwise not be tolerated in a standard model with Walrasian labor markets; as a result, any concern for stabilizing nominal wages does not translate into a concern for stabilizing nominal prices. Our model also predicts that smoothing of labor tax rates over time is a much less quantitatively-important goal of policy than standard models predict. Our results demonstrate that the level at which nominal wage rigidity is modeled -- whether simply lain on top of a Walrasian market or articulated in the context of an explicit relationship between workers and firms -- can matter a great deal for policy recommendations.

Keywords: Wages; Inflation (Finance) (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-cba, nep-dge, nep-lab and nep-mac
References: Add references at CitEc
Citations: View citations in EconPapers (15)

Downloads: (external link)
http://www.federalreserve.gov/pubs/ifdp/2007/893/default.htm (text/html)
http://www.federalreserve.gov/pubs/ifdp/2007/893/ifdp893.pdf (application/pdf)

Related works:
Journal Article: Optimal fiscal and monetary policy with costly wage bargaining (2008)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgif:893

Access Statistics for this paper

More papers in International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ; Keisha Fournillier ().