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Optimal monetary policy and downward nominal wage rigidity in frictional labor markets

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  • Abo-Zaid, Salem

Abstract

This paper studies the optimal long-run inflation rate in a labor search and matching framework in the presence of downward nominal wage rigidity. Optimal monetary policy features positive inflation in the long run; the optimal annual long-run inflation rate for the U.S. economy is slightly below 1 percent with a money demand motive and around 2 percent otherwise. Positive inflation facilitates real wage adjustments and hence it eases job creation and prevents excessive increase in unemployment following adverse productivity shocks. The findings of the paper can also be related to standard Ramsey theory of “wedge smoothing”; with positive inflation under sticky prices, the size and the volatility of the intertemporal wedge are significantly reduced.

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  • Abo-Zaid, Salem, 2013. "Optimal monetary policy and downward nominal wage rigidity in frictional labor markets," Journal of Economic Dynamics and Control, Elsevier, vol. 37(1), pages 345-364.
    • Handle: RePEc:eee:dyncon:v:37:y:2013:i:1:p:345-364
    DOI: 10.1016/j.jedc.2012.09.003
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    Cited by:

    1. Mineyama, Tomohide, 2022. "Revisiting the optimal inflation rate with downward nominal wage rigidity: The role of heterogeneity," Journal of Economic Dynamics and Control, Elsevier, vol. 139(C).
    2. Ahrens, Steffen & Pirschel, Inske & Snower, Dennis J., 2014. "A theory of wage adjustment under loss aversion," Kiel Working Papers 1977, Kiel Institute for the World Economy (IfW Kiel).
    3. Iwasaki, Yuto & Muto, Ichiro & Shintani, Mototsugu, 2021. "Missing wage inflation? Estimating the natural rate of unemployment in a nonlinear DSGE model," European Economic Review, Elsevier, vol. 132(C).
    4. Abo-Zaid, Salem, 2015. "Optimal long-run inflation with occasionally binding financial constraints," European Economic Review, Elsevier, vol. 75(C), pages 18-42.
    5. Abo-Zaid, Salem, 2015. "Optimal monetary policy with the cost channel and monopolistically-competitive banks," Journal of Macroeconomics, Elsevier, vol. 45(C), pages 284-299.
    6. Matsui, Muneya & Yoshimi, Taiyo, 2015. "Macroeconomic dynamics in a model with heterogeneous wage contracts," Economic Modelling, Elsevier, vol. 49(C), pages 72-80.

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    More about this item

    Keywords

    Downward nominal wage rigidity; Optimal monetary policy; Long-run inflation rate; Labor market frictions; Intertemporal wedge smoothing;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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