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More than average – designing monetary policy in a currency union with downward nominal wage rigidity

Author

Listed:
  • Michal Kobielarz

    (KULeuven)

  • Christian Probsting

    (KULeuven)

Abstract

Standard monetary policy in currency unions targets aggregate averages, ignoring crosssectional business cycle dispersion. Incorporating downward nominal wage rigidity into a multi-country New Keynesian framework, we analyze optimal monetary policy when asymmetric shocks generate regional labor market slack. Optimal policy pursues a capped “grease-the-wheels” strategy, balancing the benefits of eroding rigid real wages against price dispersion costs. Crucially, for a given level of aggregate unemployment, optimal policy is strictly less inflationary under cross-sectional shocks than under aggregate shocks. This occurs because inflating the union imposes costly price dispersion across all member states while easing slack in only a subset, and because terms-of-trade leakage further diminishes inflation’s effectiveness in constrained regions. Consequently, optimal monetary policy must look beyond union-wide averages and condition its stance on the share of constrained member states.

Suggested Citation

  • Michal Kobielarz & Christian Probsting, 2026. "More than average – designing monetary policy in a currency union with downward nominal wage rigidity," Working Paper Research 499, National Bank of Belgium.
    • Handle: RePEc:nbb:reswpp:202610-499
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    File URL: https://www.nbb.be/fr/publications-research/all-publications/more-average-designing-monetary-policy-currency-union-downward-nominal-wage-rigidity
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    Keywords

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    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions

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