Scandinavian Working Papers in Economics

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

No 367: Gains from Wage Flexibility and the Zero Lower Bound

Roberto Billi () and Jordi Galí ()
Additional contact information
Roberto Billi: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Jordi Galí: CREI, UPF and Barcelona GSE

Abstract: We analyze the welfare impact of greater wage exibility while taking into account explicitly the existence of the zero lower bound (ZLB) constraint on the nominal interest rate. We show that the ZLB constraint generally amplifies the adverse effects of greater wage exibility on welfare when the central bank follows a conventional Taylor rule. When demand shocks are the driving force, the presence of the ZLB implies that an increase in wage exibility reduces welfare even under the optimal monetary policy with commitment.

Keywords: labor market exibility; nominal rigidities; optimal monetary policy with commitment; Taylor rule; ZLB

JEL-codes: E24; E32; E52

42 pages, March 1, 2019

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