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Nominal v. Real Wage Rigidities in New Keynesian Models with Hiring Costs

  • Marianna Riggi
  • Massimiliano Tancioni

The introduction of labor market frictions into the New Keynesian DSGE model solves some of the main drawbacks of the baseline framework. In this paper we show that this extended model, by assuming real wage rigidities, fails to replicate the correct wage dynamics and the observed negative conditional correlation between supply shocks and employment, known as “productivity employment puzzle†. We then show that these empirical limitations can be overcome by a model incorporating nominal wage rigidities in addition to price rigidities and hiring costs. Adopting a Bayesian perspective, we estimate the dynamic properties of the model with real wage rigidities and confront them with those of the model with nominal wage rigidities, concluding that there is decisive evidence in favor of the latter.

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Paper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 107.

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Length: 42
Date of creation: Jan 2008
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Handle: RePEc:sap:wpaper:wp107
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