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Labour Markets and Monetary Policy: A New Keynesian Model with Unemployment

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  • Blanchard, Olivier J
  • Galí, Jordi

Abstract

We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation trade-off 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 labour 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 labour market frictions and real wage rigidities. We show the nature of the trade-off between inflation and unemployment stabilization, and its dependence on labour market characteristics. We draw the implications for optimal monetary policy.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6765.

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Date of creation: Mar 2008
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Handle: RePEc:cpr:ceprdp:6765

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Keywords: Labour market frictions; New Keynesian Model; real wage rigidities; search model; sticky prices; unemployment;

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  1. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
  2. Mark Gertler & Luca Sala & Antonella Trigari, 2008. "An Estimated Monetary DSGE Model with Unemployment and Staggered Nominal Wage Bargaining," Working Papers 341, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  3. Moyen, S. & Sahuc, J-G., 2004. "Incorporating Labour Market Frictions into an Optimising-Based Monetary Policy Model," Working papers, Banque de France 105, Banque de France.
  4. Antonella Trigari, 2006. "The Role of Search Frictions and Bargaining for Inflation Dynamics," Working Papers 304, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  5. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-32, March.
  6. Krause, Michael U. & Lubik, Thomas A., 2007. "The (ir)relevance of real wage rigidity in the New Keynesian model with search frictions," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(3), pages 706-727, April.
  7. Christoffel, Kai & Linzert, Tobias, 2005. "The role of real wage rigidity and labor market frictions for unemployment and inflation dynamics," Working Paper Series, European Central Bank 0556, European Central Bank.
  8. Olivier Blanchard & Jordi Galí, 2005. "Real Wage Rigidities and the New Keynesian Model," Working Papers 243, Barcelona Graduate School of Economics.
  9. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  10. Barro, Robert J, 1988. "The Persistence of Unemployment," American Economic Review, American Economic Association, vol. 78(2), pages 32-37, May.
  11. Faia, Ester, 2006. "Optimal monetary policy rules with labor market frictions," Working Paper Series, European Central Bank 0698, European Central Bank.
  12. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, Elsevier, vol. 46(2), pages 281-313, October.
  13. Carlos Thomas, 2006. "Search and Matching Frictions and Optimal Monetary Policy," CEP Discussion Papers dp0743, Centre for Economic Performance, LSE.
  14. Mark Bils & Peter J. Klenow, 2002. "Some Evidence on the Importance of Sticky Prices," NBER Working Papers 9069, National Bureau of Economic Research, Inc.
  15. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 123(4), pages 1415-1464, November.
  16. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 36(2), pages 269-300, November.
  17. Marcus Hagedorn & Iourii Manovskii, 2008. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited," American Economic Review, American Economic Association, vol. 98(4), pages 1692-1706, September.
  18. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 44(2), pages 195-222, October.
  19. Antonella Trigari, 2009. "Equilibrium Unemployment, Job Flows, and Inflation Dynamics," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 41(1), pages 1-33, 02.
  20. Rafael Domenech & Javier Andres & Javier Ferri, 2006. "Price Rigidity and the Volatility of Vacancies and Unemployment," Working Papers, International Economics Institute, University of Valencia 0601, International Economics Institute, University of Valencia.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Arnold Kling doesn’t know modern macro
    by pushmedia1 in The Ambrosini Critique on 2009-01-28 00:44:59
  2. New Keynesian models and the labour market
    by Mainly Macro in Mainly Macro on 2013-08-23 13:30:00
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