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How do nominal and real rigidities interact? A tale of the second best

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  • Duval, Romain
  • Vogel, Lukas

Abstract

This paper analyses the importance of real wage rigidities, in particular through their interaction with price stickiness, for optimal monetary policy in a calibrated small open economy DSGE model including oil in production and consumption. Blanchard and Galí (2007a) show real rigidities to introduce a trade-off between stabilising inflation and the welfare-relevant output gap. The present paper complements their findings by showing that the welfare cost of real rigidities can be substantial compared to nominal frictions. In a typical “tale of the second best”, we also show that in the presence of real wage rigidities, price stickiness can be welfare-enhancing.

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File URL: http://mpra.ub.uni-muenchen.de/27362/
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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 7282.

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Date of creation: 31 Oct 2007
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Handle: RePEc:pra:mprapa:7282

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Keywords: DSGE model; price stickiness; real wage rigidity; oil price shocks;

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  1. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 70(4), pages 825-860, October.
  2. Faia, Ester, 2007. "Ramsey monetary policy with labour market frictions," Working Paper Series, European Central Bank 0707, European Central Bank.
  3. 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).
  4. Kim, Jinill & Kim, Sunghyun Henry, 2003. "Spurious welfare reversals in international business cycle models," Journal of International Economics, Elsevier, Elsevier, vol. 60(2), pages 471-500, August.
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  6. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation stabilization and welfare: The case of a distorted steady state," Discussion Papers, Columbia University, Department of Economics 0405-04, Columbia University, Department of Economics.
  7. Blanchard, Olivier J & Galí, Jordi, 2005. "Real Wage Rigidities and the New Keynesian Model," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5375, C.E.P.R. Discussion Papers.
  8. Martin Bodenstein & Christopher J. Erceg & Luca Guerrieri, 2008. "Optimal monetary policy with distinct core and headline inflation rates," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 941, Board of Governors of the Federal Reserve System (U.S.).
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  14. A. Campolmi, 2005. "Which inflation to target? A small open economy with sticky wages indexed to past inflation," Working Papers 553, Dipartimento Scienze Economiche, Universita' di Bologna.
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  20. Filippo Altissimo & Michael Ehrmann & Frank Smets, 2006. "Inflation persistence and price-setting behaviour in the euro area – a summary of the IPN evidence," Occasional Paper Series 46, European Central Bank.
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  22. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
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Citations

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Cited by:
  1. M. Alper Çenesiz & Luís Guimarães, 2013. "Sticky Price Models, Durable Goods, and Real Wage Rigidities," CEF.UP Working Papers, Universidade do Porto, Faculdade de Economia do Porto 1305, Universidade do Porto, Faculdade de Economia do Porto.
  2. Knell, Markus, 2013. "Nominal and real wage rigidities. In theory and in Europe," Journal of Macroeconomics, Elsevier, Elsevier, vol. 36(C), pages 89-105.
  3. repec:onb:oenbwp:y::i:161:b:1 is not listed on IDEAS
  4. Vogel, Lukas, 2011. "Interacting nominal and real labour market rigidities," Economics Letters, Elsevier, Elsevier, vol. 111(3), pages 264-267, June.
  5. Romain Duval & Lukas Vogel, 2008. "Oil Price Shocks, Rigidities and the Conduct of Monetary Policy: Some Lessons from a New Keynesian Perspective," OECD Economics Department Working Papers 603, OECD Publishing.

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