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Monetary Policy, Efficiency Wages, and Nominal Wage Rigidities

  • Thomas J. Carter
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    Monetary policy can lower unemployment and have other real effects when efficiency wages are combined with some nominal rigidity. In some models, the rigidity causes a fixed nominal wage. Thus a monetary expansion that raises prices must lower real wages; this can raise employment and output. But one might conclude that at least in their current forms, efficiency wage models with nominal wage rigidities cannot be plausibly applied to monetary issues or used to justify monetary policy. With such rigidities, a monetary expansion lowers real wages, raises employment, and lowers efficiency. This paper uses a general efficiency wage model to reanalyze the effects of monetary policy. Here, a rise in the money supply raises employment but lowers output. This happens because efficiency or productivity falls when the money supply rises. The conclusion to be drawn is not that monetary expansions really are contractionary. Instead, one might conclude that, at least in their current forms, efficiency wage models with nominal wage rigidities may not be well-suited to discussions of monetary policy. Alternative models may be more useful.

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    File URL: http://college.holycross.edu/RePEc/eej/Archive/Volume31/V31N3P349_359.pdf
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    Article provided by Eastern Economic Association in its journal Eastern Economic Journal.

    Volume (Year): 31 (2005)
    Issue (Month): 3 (Summer)
    Pages: 349-359

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    Handle: RePEc:eej:eeconj:v:31:y:2005:i:3:p:349-359
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