Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 206: Optimal Monetary Policy under Downward Nominal Wage Rigidity

Mikael Carlsson () and Andreas Westermark ()
Additional contact information
Mikael Carlsson: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Andreas Westermark: Department of Economics, Uppsala University, Postal: P.O. Box 513, SE-751 20 Uppsala, Sweden

Abstract: We develop a New Keynesian model with staggered price and wage setting where downward nominal wage rigidity (DNWR) arises endogenously through the wage bargaining institutions. It is shown that the optimal (discretionary) monetary policy response to changing economic conditions then becomes asymmetric. Interestingly, we find that the welfare loss is actually slightly smaller in an economy with DNWR. This is due to that DNWR is not an additional constraint on the monetary policy problem. Instead, it is a constraint that changes the choice set and opens up for potential welfare gains due to lower wage variability. Another finding is that the Taylor rule provides a fairly good approximation of optimal policy under DNWR. In contrast, this result does not hold in the unconstrained case. In fact, under the Taylor rule, agents would clearly prefer an economy with DNWR before an unconstrained economy ex ante.

Keywords: Monetary Policy; Wage Bargaining; Downward Nominal Wage Rigidity

JEL-codes: E52; E58; J41

52 pages, April 1, 2007

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wp206.pdf PDF-file 
WP_206_Revised.pdf PDF-file Revised Working Paper

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