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The Inflation-Unemployment Trade-Off At Low Inflation

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  • Luca Antonio Ricci
  • Pierpaolo Benigno

Abstract

Wage setters take into account the future consequences of their current wage choices in the presence of downward nominal wage rigidities. Several interesting implications arise. First, a closed-form solution for a long-run Phillips curve relates average unemployment to average wage inflation; the curve is virtually vertical for high inflation rates but becomes flatter as inflation declines. Second, macroeconomic volatility shifts the Phillips curve outward, implying that stabilization policies can play an important role in shaping the trade-off. Third, nominal wages tend to be endogenously rigid also upward, at low inflation. Fourth, when inflation decreases, volatility of unemployment increases whereas the volatility of inflation decreases: this implies a long-run trade-off also between the volatility of unemployment and that of wage inflation.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/34.

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Length: 46
Date of creation: 01 Mar 2009
Date of revision:
Handle: RePEc:imf:imfwpa:09/34

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Keywords: Unemployment; Wage policy; Price adjustments; Economic models; inflation; wage; wage inflation; wages; low inflation; inflation rate; inflation rates; monetary policy; high inflation; wage level; relative price; price stability; effect of inflation; wage adjustment; monetary economics; inflation target; inflation targeting; benefits; average inflation; moderate inflation; wage adjustments; wage bargaining; effects of inflation; real interest rate; price level; gdp deflator; increase in inflation; wage increases; rate of inflation; inflationary shock; aggregate demand; wage index; inflation process; labor income; reduction in inflation; high inflation rate; wage rates; macroeconomic stability; wage increase;

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Cited by:
  1. Kim, Jinill & Ruge-Murcia, Francisco J., 2011. "Monetary policy when wages are downwardly rigid: Friedman meets Tobin," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 35(12), pages 2064-2077.
  2. Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2010. "Trend inflation, endogenous mark-ups and the non-vertical Phillips curve," wp.comunite, Department of Communication, University of Teramo 0065, Department of Communication, University of Teramo.
  3. KIM, Jinill & RUGE-MURCIA, Francisco J., 2007. "How Much Inflation is Necessary to Grease the Wheels?," Cahiers de recherche, Centre interuniversitaire de recherche en économie quantitative, CIREQ 11-2007, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  4. Di Bartolomeo, Giovanni & Tirelli, Patrizio & Acocella, Nicola, 2012. "Inflation targets and endogenous wage markups in a New Keynesian model," Journal of Macroeconomics, Elsevier, Elsevier, vol. 34(2), pages 391-403.
  5. Fagan, Gabriel & Messina, Julián, 2009. "Downward wage rigidity and optimal steady-state inflation," Working Paper Series, European Central Bank 1048, European Central Bank.
  6. Pierpaolo Benigno & Luca Antonio Ricci, 2011. "The Inflation-Output Trade-Off with Downward Wage Rigidities," American Economic Review, American Economic Association, American Economic Association, vol. 101(4), pages 1436-66, June.
  7. Farvaque, Etienne & Mihailov, Alexander, 2009. "Intergenerational Transmission of Inflation Aversion: Theory and Evidence," IRISS Working Paper Series, IRISS at CEPS/INSTEAD 2009-11, IRISS at CEPS/INSTEAD.
  8. Juan David Prada Sarmiento & Luis Eduardo Rojas Dueñas, 2009. "La elasticidad de Frisch y la transmisión de la política monetaria en Colombia," BORRADORES DE ECONOMIA 005404, BANCO DE LA REPÚBLICA.
  9. Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2011. "Trend inflation, the labor market wedge, and the non-vertical Phillips curve," wp.comunite, Department of Communication, University of Teramo 0081, Department of Communication, University of Teramo.

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