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Downward wage rigidity and optimal steady-state inflation

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  • Fagan, Gabriel
  • Messina, Julián

Abstract

This paper examines the impact of downward wage rigidity (nominal and real) on optimal steady-state inflation. For this purpose, we extend the workhorse model of Erceg, Henderson and Levin (2000) by introducing asymmetric menu costs for wage setting. We estimate the key parameters by simulated method of moments, matching key features of the cross-sectional distribution of individual wage changes observed in the data. We look at five countries (the US, Germany, Portugal, Belgium and Finland). The calibrated heterogeneous agent models are then solved for different steady state rates of inflation to derive welfare implications. We find that, across the European countries considered, the optimal steady-state rate of inflation varies between zero and 2%. For the US, the results depend on the dataset used, with estimates of optimal inflation varying between 2% and 5%. JEL Classification: E31, E52, J4

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1048.

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Date of creation: Apr 2009
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Handle: RePEc:ecb:ecbwps:20091048

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Keywords: downward wage rigidity; DSGE Models; optimal inflation;

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References

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  1. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2006. "SIGMA: a new open economy model for policy analysis," International Finance Discussion Papers 835, Board of Governors of the Federal Reserve System (U.S.).
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Citations

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Cited by:
  1. Julián Messina & Philip Du Caju & Cláudia Filipa Duarte & Niels Lynggård Hansen & Mario Izquierdo, 2010. "The incidence of nominal and real wage rigidity: an individual-based sectoral approach," Banco de Espa�a Working Papers 1022, Banco de Espa�a.
  2. Maarten Dossche, 2009. "Understanding Inflation Dynamics.Where Do We Stand?," Review of Business and Economics, Katholieke Universiteit Leuven, Faculteit Economie en Bedrijfswetenschappen, vol. 0(2), pages 209-227.
  3. Benigno, Pierpaolo & Ricci, Luca Antonio & Surico, Paolo, 2010. "Unemployment and Productivity in the Long Run: the Role of Macroeconomic Volatility," CEPR Discussion Papers 8014, C.E.P.R. Discussion Papers.
  4. Pierpaolo Benigno & Luca Antonio Ricci, 2010. "The Inflation-Output Trade-off with Downward Wage Rigidities," EIEF Working Papers Series 1020, Einaudi Institute for Economics and Finance (EIEF), revised Apr 2010.
  5. Steffen Ahrens & Dennis Snower, 2012. "Envy, Guilt, and the Phillips Curve," CESifo Working Paper Series 3717, CESifo Group Munich.
  6. G. de Walque & M. Druant & Ph. Du Caju & C. Fuss, 2010. "Lessons of the Wage Dynamics Network," Economic Review, National Bank of Belgium, issue I, pages 55-75, June.
  7. Frank R. Smets, 2010. "Commetary: modeling inflation after the crisis," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 221-234.
  8. Pierpaolo Benigno & Luca Antonio Ricci, 2008. "The Inflation-Unemployment Trade-Off at Low Inflation," NBER Working Papers 13986, National Bureau of Economic Research, Inc.
  9. Stefan Reitz & Ulf. D. Slopek, 2012. "Fixing the Phillips Curve: The Case of Downward Nominal Wage Rigidity in the US," Kiel Working Papers 1795, Kiel Institute for the World Economy.

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