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Real Wages and Monetary Policy: A DSGE Approach

  • Bryan Perry

    ()

    (Department of Economics, Brigham Young University)

  • Kerk L. Phillips

    ()

    (Department of Economics, Brigham Young University)

  • David E. Spencer

    ()

    (Department of Economics, Brigham Young University)

Economists have long investigated the cyclical behavior of real wages in order to draw inferences regarding the relative stickiness of prices and wages. Recent studies have adopted techniques intended to identify monetary shocks and examined the response of real wages and output or employment to such shocks. A finding that real wages are procyclical in response to a positive monetary policy shock, for example, is taken as evidence that prices are stickier than wages. In this paper, we show that factors other than wage and price stickiness affect the response of real wages to a monetary policy shock. Accordingly, examining the response of real wages is not enough to sort out the relative stickiness of prices and wages. We use two prominent DSGE models to help us address this issue. These models incorporate both sticky wages and prices but in different ways. The first model (Huang, Liu, and Phaneuf, American Economic Review, 2004) is relatively simple and is not intended for policy analysis. Its relative simplicity allows us to approach the issues both analytically and through simulations. The second model (Smets and Wouters, American Economic Review, 2007) is a relatively complex model of the U.S. economy with many frictions and intended to be useful for policy analysis. Because of its complexity, we must rely principally on simulation exercises. Using these models we offer robust evidence that the real wage response to monetary policy is affected in important ways by properties of the economy other than stickiness of wages and prices, such as the importance of intermediate goods in the production process and the size of key elasticities. Consequently, we cannot appropriately infer the relative stickiness of wages and prices from examining only the response of real wages to a monetary policy shock.

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Paper provided by Brigham Young University, Department of Economics, BYU Macroeconomics and Computational Laboratory in its series BYU Macroeconomics and Computational Laboratory Working Paper Series with number 2012-02.

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Length: 34 pages
Date of creation: Apr 2012
Date of revision:
Publication status: Published in Journal of Economic Studies, forthcoming
Handle: RePEc:byu:byumcl:201202
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Web page: https://economics.byu.edu/Pages/MacroLab/Home.aspx

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  1. repec:nbr:nberre:0126 is not listed on IDEAS
  2. Huw Dixon & Engin Kara, 2005. "How to Compare Taylor and Calvo Contracts: a comment on Michael Kiley," CDMA Working Paper Series 200504, Centre for Dynamic Macroeconomic Analysis.
  3. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  4. Spencer, David E, 1998. "The Relative Stickiness of Wages and Prices," Economic Inquiry, Western Economic Association International, vol. 36(1), pages 120-37, January.
  5. Kevin X.D. Huang & Zheng Liu & Louis Phaneuf, 2002. "Why does the cyclical behavior of real wages change over time?," Research Working Paper RWP 02-09, Federal Reserve Bank of Kansas City.
  6. Fischer, Stanley, 1988. "Recent Developments in Macroeconomics," Economic Journal, Royal Economic Society, vol. 98(391), pages 294-339, June.
  7. Taylor, John B., 1999. "Staggered price and wage setting in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 15, pages 1009-1050 Elsevier.
  8. Frank Smets & Raf Wouters, 2007. "Shocks and Frictions in US Business Cycles : a Bayesian DSGE Approach," Working Paper Research 109, National Bank of Belgium.
  9. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
  10. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  11. Gamber, Edward N & Joutz, Frederick L, 1993. "The Dynamic Effects of Aggregate Demand and Supply Disturbances: Comment," American Economic Review, American Economic Association, vol. 83(5), pages 1387-93, December.
  12. Miles S. Kimball, 1995. "The Quantitative Analytics of the Basic Neomonetarist Model," NBER Working Papers 5046, National Bureau of Economic Research, Inc.
  13. Charles A. Fleischman, 1999. "The causes of business cycles and the cyclicality of real wages," Finance and Economics Discussion Series 1999-53, Board of Governors of the Federal Reserve System (U.S.).
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