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Can Wage and Price Stickiness Account for Sizeable Costs of Business Cycle Fluctuations?

  • Matthias Paustian
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    This paper asks the following two questions: First, can a model with nominal rigidities in wage and price setting account for the average welfare costs of business cycle fluctuations identified in Gali, Gertler, and Lopez- Salido (2003)? Second, do we need to agree on a particular scheme for nominal rigidities to answer that question? We compute a quadratic approximation to agents expected lifetime utility and evaluate welfare for different modeling schemes of nominal rigidities that all have the same average duration of contracts. Calvo (1983) wage and price contracts can deliver sizeable welfare costs, but other contracts of the same average stickiness cannot. Calvo (1983) contracts can imply welfare costs that are up to 4 times higher than those implied by overlapping contracts in the spirit of Taylor (1980) or Wolman (1999). Furthermore, the sticky information framework of Mankiw and Reis (2002) may generate welfare costs that are even smaller. This paper calls for more research into the origins of wage and price stickiness.

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    File URL: http://www.wiwi.uni-bonn.de/bgsepapers/bonedp/bgse18_2004.pdf
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    Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse18_2004.

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    Length: 34
    Date of creation: Oct 2004
    Date of revision:
    Handle: RePEc:bon:bonedp:bgse18_2004
    Contact details of provider: Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
    Fax: +49 228 73 6884
    Web page: http://www.bgse.uni-bonn.de

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