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How Much Inflation is Necessary to Grease the Wheels?

  • Kim, Jinill
  • Ruge-Murcia, Francisco J.

This paper studies Tobin's proposition that inflation "greases" the wheels of the labor market. The analysis is carried out using a simple dynamic stochastic general equilibrium model with asymmetric wage adjustment costs. Optimal inflation is determined by a benevolent government that maximizes the households' welfare. The Simulated Method of Moments is used to estimate the nonlinear model based on its second-order approximation. Econometric results indicate that nominal wages are downwardly rigid and that the optimal level of grease inflation for the U.S. economy is about 1.2 percent per year, with a 95% confidence interval ranging from 0.2 to 1.6 percent.

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File URL: http://hdl.handle.net/1866/2143
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Paper provided by Universite de Montreal, Departement de sciences economiques in its series Cahiers de recherche with number 2007-10.

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Length: 27 pages
Date of creation: 2007
Handle: RePEc:mtl:montde:2007-10
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