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Optimal Monetary Policy under Downward Nominal Wage Rigidity

  • Carlsson, Mikael

    ()

    (Research Department)

  • Westermark, Andreas

    ()

    (Department of Economics)

We develop a New Keynesian model with staggered price and wage setting where downward nominal wage rigidity (DNWR) arises endogenously through the wage bargaining institutions. It is shown that the optimal (discretionary) monetary policy response to changing economic conditions then becomes asymmetric. Interestingly, we find that the welfare loss is actually slightly smaller in an economy with DNWR. This is due to that DNWR is not an additional constraint on the monetary policy problem. Instead, it is a constraint that changes the choice set and opens up for potential welfare gains due to lower wage variability. Another finding is that the Taylor rule provides a fairly good approximation of optimal policy under DNWR. In contrast, this result does not hold in the unconstrained case. In fact, under the Taylor rule, agents would clearly prefer an economy with DNWR before an unconstrained economy ex ante.

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Paper provided by Uppsala University, Department of Economics in its series Working Paper Series with number 2007:15.

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Length: 52 pages
Date of creation: 10 Apr 2007
Date of revision:
Handle: RePEc:hhs:uunewp:2007_015
Contact details of provider: Postal: Department of Economics, Uppsala University, P. O. Box 513, SE-751 20 Uppsala, Sweden
Phone: + 46 18 471 25 00
Fax: + 46 18 471 14 78
Web page: http://www.nek.uu.se/
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