Optimal Monetary Policy under Downward Nominal Wage Rigidity

Mikael Carlsson and Andreas Westermark

No 2007:15, Working Paper Series from Uppsala University, Department of Economics

Abstract: We develop a New Keynesian model with staggered price and wage setting where downward nominal wage rigidity (DNWR) arises endogenously through the wage bargaining institutions. It is shown that the optimal (discretionary) monetary policy response to changing economic conditions then becomes asymmetric. Interestingly, we find that the welfare loss is actually slightly smaller in an economy with DNWR. This is due to that DNWR is not an additional constraint on the monetary policy problem. Instead, it is a constraint that changes the choice set and opens up for potential welfare gains due to lower wage variability. Another finding is that the Taylor rule provides a fairly good approximation of optimal policy under DNWR. In contrast, this result does not hold in the unconstrained case. In fact, under the Taylor rule, agents would clearly prefer an economy with DNWR before an unconstrained economy ex ante.

Keywords: Monetary Policy; Wage Bargaining; Downward Nominal Wage Rigidity (search for similar items in EconPapers)
JEL-codes: E52 E58 J41 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2007-04-10
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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