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How Monetary Policy can have Permanent Real Effects with Only Temporary Nominal Rigidity
Author(s) -
McDonald Ian M.,
Scully Hugh
Publication year - 2001
Publication title -
scottish journal of political economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.4
H-Index - 46
eISSN - 1467-9485
pISSN - 0036-9292
DOI - 10.1111/1467-9485.00213
Subject(s) - economics , wage , monetary policy , loss aversion , rigidity (electromagnetism) , real wages , monetary economics , macroeconomics , labour economics , microeconomics , structural engineering , engineering
A macroeconomic model is developed in which the psychological concept of loss aversion is incorporated into workers’ preferences. The impact of monetary policy in the presence of loss aversion depends on the specification of the reference wage. The plausible specification that a worker’s reference wage is the real wage she was paid in the previous period is considered in detail. Specifying the reference wage in this way, we show that an unanticipated change in monetary policy has a permanent, real effect when short term labour contracts are written in nominal wages.