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Optimal Monetary Policy and Downward Nominal Wage Rigidity in Frictional Labor Markets

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  • Abo-Zaid, Salem

Abstract

Recent empirical evidence suggests that nominal wages in the U.S. are downwardly rigid. This paper studies optimal monetary policy in a labor search and matching framework under the presence of Downward Nominal Wage Rigidity (DNWR). The study shows that when nominal wages are downwardly rigid, optimal monetary policy targets a positive inflation rate; the annual long-run inflation rate is around 2 percent. Positive inflation in this environment “greases the wheels” of the labor market by facilitating real wage adjustments, and hence it eases job creation and prevents excessive increase in unemployment. In addition, there is an asymmetry in the response of the economy to positive and negative productivity shocks, particularly those of large sizes. Finally, the optimal long-run inflation rate predicted by this study is considerably higher than in otherwise neoclassical labor markets, suggesting that the nature of the labor market in which DNWR is studied can matter for policy recommendations.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 17489.

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Date of creation: 24 Sep 2009
Handle: RePEc:pra:mprapa:17489
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Keywords: Downward Nominal Wage Rigidity; Optimal Monetary Policy; Long Run Inflation Rate; Labor Market Frictions; Labor Search and Matching.;

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Find related papers by JEL classification:
  • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
  • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
  • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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Cited by:

  1. Ahrens, Steffen & Pirschel, Inske & Snower, Dennis J., 2014. "A theory of wage adjustment under loss aversion," Kiel Working Papers 1977, Kiel Institute for the World Economy (IfW).
  2. Abo-Zaid, Salem, 2015. "Optimal long-run inflation with occasionally binding financial constraints," European Economic Review, Elsevier, vol. 75(C), pages 18-42.
  3. Abo-Zaid, Salem, 2015. "Optimal monetary policy with the cost channel and monopolistically-competitive banks," Journal of Macroeconomics, Elsevier, vol. 45(C), pages 284-299.
  4. Matsui, Muneya & Yoshimi, Taiyo, 2015. "Macroeconomic dynamics in a model with heterogeneous wage contracts," Economic Modelling, Elsevier, vol. 49(C), pages 72-80.

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