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Inequality, nominal rigidities, and aggregate demand

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  • Diz, Sebastian
  • Giarda, Mario
  • Romero, Damián

Abstract

This paper studies the gains from wage flexibility in a New Keynesian model with price and wage rigidities and incomplete asset markets. When a fraction of households consume solely out of their labor income and have no access to financial markets, the real wage, and therefore, the relative nominal rigidities between wages and prices, directly determine the economy’s aggregate demand. We show that when wages are flexible relative to prices, economic downturns are accompanied by a pronounced decline in real wages, which depresses aggregate demand, and exacerbates the economy’s volatility. In this context, we conclude that enhancing wage flexibility when prices are highly rigid is an undesirable policy prescription.

Suggested Citation

  • Diz, Sebastian & Giarda, Mario & Romero, Damián, 2023. "Inequality, nominal rigidities, and aggregate demand," European Economic Review, Elsevier, vol. 158(C).
    • Handle: RePEc:eee:eecrev:v:158:y:2023:i:c:s0014292123001587
    DOI: 10.1016/j.euroecorev.2023.104529
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    Cited by:

    1. Bilbiie, F. O. & Trabandt, M., 2023. "Sticky Prices or Sticky Wages? An Equivalence Result," Cambridge Working Papers in Economics 2369, Faculty of Economics, University of Cambridge.
    2. Makram El-Shagi & Steven Yamarik, 2024. "The Effect of Monetary Policy Shocks on Income Inequality across US states," CFDS Discussion Paper Series 2024/4, Center for Financial Development and Stability at Henan University, Kaifeng, Henan, China.

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    More about this item

    Keywords

    Nominal rigidities; Two-agent models; Business cycles; Monetary policy; Consumption;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • 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

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