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A New Keynesian model with unemployment

Author

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  • Blanchard, Olivier
  • Galí, Jordi

Abstract

We develop a utility based model of fluctuations, with nominal rigidities, and unemployment. In doing so, we combine two strands of research: the New Keynesian model with its focus on nominal rigidities, and the Diamond-Mortensen-Pissarides model, with its focus on labor market frictions and unemployment. In developing this model, we proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and we draw the implications for optimal monetary policy.

Suggested Citation

  • Blanchard, Olivier & Galí, Jordi, 2006. "A New Keynesian model with unemployment," CFS Working Paper Series 2007/08, Center for Financial Studies (CFS).
  • Handle: RePEc:zbw:cfswop:200708
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    References listed on IDEAS

    as
    1. Moyen, Stephane & Sahuc, Jean-Guillaume, 2005. "Incorporating labour market frictions into an optimising-based monetary policy model," Economic Modelling, Elsevier, vol. 22(1), pages 159-186, January.
    2. Carl E. Walsh, 2005. "Labor Market Search, Sticky Prices, and Interest Rate Policies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(4), pages 829-849, October.
    3. Summers, Lawrence H, 1991. " The Scientific Illusion in Empirical Macroeconomics," Scandinavian Journal of Economics, Wiley Blackwell, vol. 93(2), pages 129-148.
    4. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
    5. Antonella Trigari, 2006. "The Role of Search Frictions and Bargaining for Inflation Dynamics," Working Papers 304, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    6. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
    7. Rafael Domenech & Javier Andres & Javier Ferri, 2006. "Price Rigidity and the Volatility of Vacancies and Unemployment," Working Papers 0601, International Economics Institute, University of Valencia.
    8. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-132, March.
    9. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March.
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    More about this item

    Keywords

    New Keynesian Model; Labor Market Frictions; Search Model; Unemployment; Sticky Prices; Real Wage Rigidities;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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