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Monetary policy when wages are downwardly rigid: Friedman meets Tobin

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  • Kim, Jinill
  • Ruge-Murcia, Francisco J.

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.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 12 ()
Pages: 2064-2077

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:12:p:2064-2077

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Web page: http://www.elsevier.com/locate/jedc

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Keywords: Downward nominal wage rigidity; Asymmetric effects of monetary policy; Optimal inflation; Nonlinear dynamics;

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References

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Cited by:
  1. Sacht, Stephen & Franke, Reiner & Jang, Tae-Seok, 2013. "Moment Matching versus Bayesian Estimation: Backward-Looking Behaviour in a New-Keynesian Baseline Model," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79694, Verein für Socialpolitik / German Economic Association.
  2. Abo-Zaid, Salem, 2013. "Optimal monetary policy and downward nominal wage rigidity in frictional labor markets," Journal of Economic Dynamics and Control, Elsevier, vol. 37(1), pages 345-364.
  3. Franke, Reiner & Jang, Tae-Seok & Sacht, Stephen, 2011. "Moment matching versus Bayesian estimation: Backward-looking behaviour in the new-Keynesian three-equations model," Economics Working Papers 2011,10, Christian-Albrechts-University of Kiel, Department of Economics.
  4. Carlsson, Mikael & Westermark, Andreas, 2012. "Labor-Market Frictions and Optimal Inflation," Working Paper Series 259, Sveriges Riksbank (Central Bank of Sweden).
  5. Caterina Mendicino, 2012. "Collateral Requirements: Macroeconomic Fluctuations and Macro-Prudential Policy," Working Papers w201211, Banco de Portugal, Economics and Research Department.

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