IDEAS home Printed from https://ideas.repec.org/p/fip/fedgif/893.html
   My bibliography  Save this paper

Optimal fiscal and monetary policy with costly wage bargaining

Author

Abstract

Costly nominal wage adjustment has received renewed attention in the design of optimal policy. In this paper, we embed costly nominal wage adjustment into the modern theory of frictional labor markets to study optimal fiscal and monetary policy. Our main result is that the optimal rate of price inflation is highly volatile over time despite the presence of sticky nominal wages. This finding contrasts with results obtained using standard sticky-wage models, which employ Walrasian labor markets at their core. The presence of shared rents associated with the formation of long-term employment relationships sets our model apart from previous work on this topic. The existence of rents implies that the optimal policy is willing to tolerate large fluctuations in real wages that would otherwise not be tolerated in a standard model with Walrasian labor markets; as a result, any concern for stabilizing nominal wages does not translate into a concern for stabilizing nominal prices. Our model also predicts that smoothing of labor tax rates over time is a much less quantitatively-important goal of policy than standard models predict. Our results demonstrate that the level at which nominal wage rigidity is modeled -- whether simply lain on top of a Walrasian market or articulated in the context of an explicit relationship between workers and firms -- can matter a great deal for policy recommendations.

Suggested Citation

  • David M. Arseneau & Sanjay K. Chugh, 2007. "Optimal fiscal and monetary policy with costly wage bargaining," International Finance Discussion Papers 893, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:893
    as

    Download full text from publisher

    File URL: http://www.federalreserve.gov/pubs/ifdp/2007/893/default.htm
    Download Restriction: no

    File URL: http://www.federalreserve.gov/pubs/ifdp/2007/893/ifdp893.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877, December.
    2. Antonella Trigari, 2006. "The Role of Search Frictions and Bargaining for Inflation Dynamics," Working Papers 304, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    3. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 825-860.
    4. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under sticky prices," Journal of Economic Theory, Elsevier, vol. 114(2), pages 198-230, February.
    5. Chugh, Sanjay K., 2007. "Optimal inflation persistence: Ramsey taxation with capital and habits," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1809-1836, September.
    6. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
    7. David M. Arseneau & Ryan Chahrour & Sanjay K. Chugh & Alan Finkelstein Shapiro, 2015. "Optimal Fiscal and Monetary Policy in Customer Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(4), pages 617-672, June.
    8. Cooley, Thomas F. & Quadrini, Vincenzo, 2004. "Optimal monetary policy in a Phillips-curve world," Journal of Economic Theory, Elsevier, vol. 118(2), pages 174-208, October.
    9. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    10. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    11. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
    12. David M. Arseneau & Sanjay K. Chugh, 2006. "Ramsey Meets Hosios: The Optimal Capital Tax and Labor Market Efficiency," 2006 Meeting Papers 568, Society for Economic Dynamics.
    13. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
    14. Aruoba, S. Boragan & Chugh, Sanjay K., 2010. "Optimal fiscal and monetary policy when money is essential," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1618-1647, September.
    15. Arseneau, David M. & Chugh, Sanjay K., 2008. "Optimal fiscal and monetary policy with costly wage bargaining," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1401-1414, November.
    16. Krause, Michael U. & Lubik, Thomas A., 2007. "The (ir)relevance of real wage rigidity in the New Keynesian model with search frictions," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 706-727, April.
    17. Faia, Ester, 2008. "Optimal monetary policy rules with labor market frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1600-1621, May.
    18. Sanjay K. Chugh, 2006. "Optimal Fiscal and Monetary Policy with Sticky Wages and Sticky Prices," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 683-714, October.
    19. Iván Werning, 2007. "Optimal Fiscal Policy with Redistribution," The Quarterly Journal of Economics, Oxford University Press, vol. 122(3), pages 925-967.
    20. Carl E. Walsh, 2005. "Labor Market Search, Sticky Prices, and Interest Rate Policies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(4), pages 829-849, October.
    21. Olivier Blanchard & Jordi Galí, 2007. "Real Wage Rigidities and the New Keynesian Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 35-65, February.
    22. Olivier Blanchard & Jordi Gali, 2006. "A new Keynesian model with unemployment," Working Paper Research 92, National Bank of Belgium.
    23. Christoffel, Kai & Linzert, Tobias, 2005. "The role of real wage rigidity and labor market frictions for unemployment and inflation dynamics," Working Paper Series 556, European Central Bank.
    24. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
    25. Mark Gertler & Antonella Trigari, 2009. "Unemployment Fluctuations with Staggered Nash Wage Bargaining," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 38-86, February.
    26. Scott, Andrew, 2007. "Optimal taxation and OECD labor taxes," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 925-944, April.
    27. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 519-539, August.
    28. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model: Expanded Version," NBER Working Papers 11417, National Bureau of Economic Research, Inc.
    29. Barro, Robert J., 1977. "Long-term contracting, sticky prices, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 3(3), pages 305-316, July.
    30. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-132, March.
    31. Oliver Jean Blanchard & Peter Diamond, 1989. "The Beveridge Curve," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 1-76.
    32. Svensson, Lars E O, 1985. "Money and Asset Prices in a Cash-in-Advance Economy," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 919-944, October.
    33. Marvin Goodfriend & Robert G. King, 2001. "The Case for Price Stability," NBER Working Papers 8423, National Bureau of Economic Research, Inc.
    34. Arthur J. Hosios, 1990. "On The Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 279-298.
    35. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 575-607, April.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Faia, Ester, 2009. "Ramsey monetary policy with labor market frictions," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 570-581, May.
    2. Abo-Zaid, Salem, 2013. "Optimal monetary policy and downward nominal wage rigidity in frictional labor markets," Journal of Economic Dynamics and Control, Elsevier, vol. 37(1), pages 345-364.
    3. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
    4. David M. Arseneau & Ryan Chahrour & Sanjay K. Chugh & Alan Finkelstein Shapiro, 2015. "Optimal Fiscal and Monetary Policy in Customer Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(4), pages 617-672, June.
    5. Kohlbrecher, Britta, 2019. "The (ir)relevance of real wage rigidity for optimal monetary policy," FAU Discussion Papers in Economics 07/2019, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.
    6. Chugh, Sanjay K. & Lechthaler, Wolfgang & Merkl, Christian, 2018. "Optimal fiscal policy with labor selection," Journal of Economic Dynamics and Control, Elsevier, vol. 94(C), pages 142-189.
    7. David M. Arseneau & Sanjay K. Chugh, 2008. "Competitive search equilibrium in a DSGE model," International Finance Discussion Papers 929, Board of Governors of the Federal Reserve System (U.S.).
    8. Gregory De Walque & Olivier Pierrard & Henri Sneessens & Raf Wouters, 2009. "Sequential Bargaining in a Neo-Keynesian Model with Frictional Unemployment and Staggered Wage Negotiations," Annals of Economics and Statistics, GENES, issue 95-96, pages 223-250.
    9. Federico Ravenna & Carl E. Walsh, 2009. "The welfare consequences of monetary policy," Working Paper Series 2009-12, Federal Reserve Bank of San Francisco.
    10. Sergio A. Lago Alves, 2018. "Monetary Policy, Trend Inflation, and Unemployment Volatility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(4), pages 637-673, June.
    11. Faia, Ester, 2008. "Optimal monetary policy rules with labor market frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1600-1621, May.
    12. Kohlbrecher, Britta, 2016. "Optimal Monetary Policy under Rigid Wages and Decreasing Returns," VfS Annual Conference 2016 (Augsburg): Demographic Change 145867, Verein für Socialpolitik / German Economic Association.
    13. Federico Di Pace & Matthias Hertweck, 2019. "Labor Market Frictions, Monetary Policy, and Durable Goods," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 32, pages 274-304, April.
    14. Ester Faia & Wolfgang Lechthaler & Christian Merkl, 2014. "Labor Selection, Turnover Costs, and Optimal Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(1), pages 115-144, February.
    15. Olivier Blanchard & Jordi Galí, 2010. "Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 1-30, April.
    16. Galí, Jordi, 2010. "Monetary Policy and Unemployment," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 10, pages 487-546, Elsevier.
    17. Christoffel, Kai & Costain, James & de Walque, Gregory & Kuester, Keith & Linzert, Tobias & Millard, Stephen & Pierrard, Olivier, 2009. "Inflation dynamics with labour market matching: assessing alternative specifications," Working Paper Series 1053, European Central Bank.
    18. Sergio A. Lago Alves, 2012. "Trend Inflation and the Unemployment Volatility Puzzle," Working Papers Series 277, Central Bank of Brazil, Research Department.
    19. Nikolas Kontogiannis, 2015. "Optimal monetary policy in a currency union with labour market heterogeneity," Working Papers 2015.04, International Network for Economic Research - INFER.
    20. David M. Arseneau & Sanjay K. Chugh, 2012. "Tax Smoothing in Frictional Labor Markets," Journal of Political Economy, University of Chicago Press, vol. 120(5), pages 926-985.

    More about this item

    Keywords

    Wages; Inflation (Finance);

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedgif:893. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Ryan Wolfslayer ; Keisha Fournillier (email available below). General contact details of provider: https://edirc.repec.org/data/frbgvus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.