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A new Keynesian model with unemployment

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Author Info
Olivier Blanchard (MIT, NBER)
Jordi Gali (Barcelona, Universitat Pompeu Fabra (UPF), Centre de Recerca en Economia Internacional (CREI), CEPR)

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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 Keynesian 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 efficient 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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Paper provided by National Bank of Belgium in its series Research series with number 200610-4.

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Length: 57 pages
Date of creation: Oct 2006
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Handle: RePEc:nbb:reswpp:200610-4

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

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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