Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployment

Olivier Blanchard and Jordi Galí

No 13897, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation tradeoff and for the conduct of monetary policy. We proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We show the role of labor market frictions and real wage rigidities in determining the effects of productivity shocks on unemployment. We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of labor market frictions and real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and its dependence on labor market characteristics. We draw the implications for optimal monetary policy.

JEL-codes: E3 E31 E32 E52 (search for similar items in EconPapers)
Date: 2008-03
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-upt
Note: EFG
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (45)

Published as Olivier Blanchard & Jordi Gali, 2010. "Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 1-30, April.

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Journal Article: Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment (2010)
Working Paper: Labour Markets and Monetary Policy: A New Keynesian Model with Unemployment (2008)
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