Costly nominal wage adjustment has received renewed attention in the design of optimal policy. In this paper, we embed costly nominal wage adjustment into the modern theory of frictional labor markets to study optimal fiscal and monetary policy. Our main result is that the optimal rate of price inflation is highly volatile over time despite the presence of sticky nominal wages. This finding contrasts with results obtained using standard sticky-wage models, which employ Walrasian labor markets at their core. The presence of shared rents associated with the formation of long-term employment relationships sets our model apart from previous work on this topic. The existence of rents implies that the optimal policy is willing to tolerate large fluctuations in real wages that would otherwise not be tolerated in a standard model with Walrasian labor markets; as a result, any concern for stabilizing nominal wages does not translate into a concern for stabilizing nominal prices. Our model also predicts that smoothing of labor tax rates over time is a much less quantitatively-important goal of policy than standard models predict. Our results demonstrate that the level at which nominal wage rigidity is modeled -- whether simply lain on top of a Walrasian market or articulated in the context of an explicit relationship between workers and firms -- can matter a great deal for policy recommendations.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
file. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Did you know? You can include your works in the database easily by uploading them on the Munich Personal RePEc Archive (MPRA) if you do not have access to an institutional RePEc archive.