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The Inflation-Output Trade-off with Downward Wage Rigidities

  • Pierpaolo Benigno

    (LUISS Guido Carli and EIEF)

  • Luca Antonio Ricci

    (IMF Research Department)

In the presence of downward nominal wage rigidities, wage setters take into account the future consequences of their current wage choices, when facing both idiosyncratic and aggregate shocks. We derive a closed-form solution for a longrun Phillips curve which relates average output gap to average wage inflation: it is virtually vertical at high inflation and flattens at low inflation. Macroeconomic volatility shifts the curve outwards and reduces output. The results imply that stabilization policies play an important role, and that optimal inflation may be positive and differ across countries with different macroeconomic volatility.

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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1020.

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Length: 41 pages
Date of creation: 2010
Date of revision: Apr 2010
Handle: RePEc:eie:wpaper:1020
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