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A New Keynesian Model with Unemployment

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  • Olivier Blanchard
  • Jordi Gali

Abstract

We develop a utility based model of fluctuations, with nominal rigidities, and unemployment. In doing so, we combine two strands of research: the New Key- nesian model with its focus on nominal rigidities, and the Diamond-Mortensen-Pissarides model, with its focus on labor market frictions and unemployment. In developing this model, 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 effcient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in 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 real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and we draw the implications for optimal monetary policy.

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1335.

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Length: 43 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:kie:kieliw:1335

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Keywords: new Keynesian model; labor market frictions; search model; unemployment; sticky prices; real wage rigidities;

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References

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  1. 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.
  2. 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.
  3. 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.
  4. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, American Economic Association, vol. 95(1), pages 25-49, March.
  5. 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.
  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," IZA Discussion Papers 1896, Institute for the Study of Labor (IZA).
  8. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, American Economic Association, vol. 95(1), pages 50-65, March.
  9. Cheron, Arnaud & Langot, Francois, 2000. "The Phillips and Beveridge curves revisited," Economics Letters, Elsevier, Elsevier, vol. 69(3), pages 371-376, December.
  10. Trigari, Antonella, 2004. "Equilibrium unemployment, job flows and inflation dynamics," Working Paper Series, European Central Bank 0304, European Central Bank.
  11. Barro, Robert J, 1988. "The Persistence of Unemployment," American Economic Review, American Economic Association, American Economic Association, vol. 78(2), pages 32-37, May.
  12. Summers, Lawrence H, 1991. " The Scientific Illusion in Empirical Macroeconomics," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 93(2), pages 129-48.
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