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How Do Nominal and Real Rigidities Interact? A Tale of the Second Best
Author(s) -
DUVAL ROMAIN,
VOGEL LUKAS
Publication year - 2012
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.1538-4616.2012.00540.x
Subject(s) - economics , wage , inflation (cosmology) , indexation , new keynesian economics , real wages , welfare , output gap , price setting , deadweight loss , keynesian economics , monetary economics , econometrics , monetary policy , microeconomics , labour economics , market economy , physics , theoretical physics
This paper analyzes the importance of real wage rigidities, in particular through their interaction with price stickiness, in a New Keynesian model. Real wage rigidities result from a combination of staggered wage setting and partial indexation of nonreset wages to past inflation. Blanchard and Galí (2007) show real rigidities to introduce a trade‐off between stabilizing inflation and the welfare‐relevant output gap. The present paper complements their findings by showing that the welfare costs of real rigidities can be substantial compared to nominal frictions. In a typical “tale of the second best,” we also show that in the presence of real wage rigidities, higher price stickiness can be welfare enhancing.