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Labor markets and monetary policy: A new-Keynesian model with unemployement

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  • Olivier Blanchard
  • Jordi Galí

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Abstract

We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation trade- off and for the conduct of monetary policy. 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 un- employment. We show the role of labor market frictions and real wage rigidities in determining the effects of productivity shocks on 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 labor market frictions and real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and its dependence on labor market characteristics. We draw the implications for optimal monetary policy.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1076.

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Date of creation: Mar 2006
Date of revision: Mar 2008
Handle: RePEc:upf:upfgen:1076

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Web page: http://www.econ.upf.edu/

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

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  1. Moyen, Stephane & Sahuc, Jean-Guillaume, 2005. "Incorporating labour market frictions into an optimising-based monetary policy model," Economic Modelling, Elsevier, vol. 22(1), pages 159-186, January.
  2. Mark Bils & Peter J. Klenow, 2002. "Some Evidence on the Importance of Sticky Prices," NBER Working Papers 9069, National Bureau of Economic Research, Inc.
  3. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  4. Thomas Lubik & Michael Krause, 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Economics Working Paper Archive 504, The Johns Hopkins University,Department of Economics.
  5. Marcus Hagedorn & Iourii Manovskii, 2007. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited," IEW - Working Papers 351, Institute for Empirical Research in Economics - University of Zurich.
  6. Barro, Robert J, 1988. "The Persistence of Unemployment," American Economic Review, American Economic Association, vol. 78(2), pages 32-37, May.
  7. Olivier Blanchard & Jordi Galí, 2005. "Real Wage Rigidities and the New Keynesian Model," Working Papers 243, Barcelona Graduate School of Economics.
  8. Luca Sala & Antonella Trigari & Mark Gertler, 2007. "An Estimated Monetary DSGE Model with Unemployment and Staggered Nominal Wage Bargaining," 2007 Meeting Papers 353, Society for Economic Dynamics.
  9. 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.
  10. Christoffel, Kai & Linzert, Tobias, 2005. "The role of real wage rigidity and labor market frictions for unemployment and inflation dynamics," Working Paper Series 0556, European Central Bank.
  11. Faia, Ester, 2006. "Optimal monetary policy rules with labor market frictions," Working Paper Series 0698, European Central Bank.
  12. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  14. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
  15. Trigari, Antonella, 2004. "Equilibrium unemployment, job flows and inflation dynamics," Working Paper Series 0304, European Central Bank.
  16. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
  17. Rafael Domenech & Javier Andres & Javier Ferri, 2006. "Price Rigidity and the Volatility of Vacancies and Unemployment," Working Papers 0601, International Economics Institute, University of Valencia.
  18. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-32, March.
  19. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
  20. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
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  1. New Keynesian models and the labour market
    by Mainly Macro in Mainly Macro on 2013-08-23 13:30:00
  2. Arnold Kling doesnâ??t know modern macro
    by pushmedia1 in The Ambrosini Critique on 2009-01-28 00:44:59
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