Working Paper Series,
Stockholm University, Swedish Institute for Social Research

Abstract: We derive a long-run Phillips curve that is negatively sloped at low inflation rates. Due to exogenous changes, unions want to redistribute wages across different members also in the long run. Wage stickiness, inflation targeting and union solidarity are central characteristics of our New Keynesian model. In the model, high enough inflation becomes the grease of the economy that allows wage redistribution across unions without causing unemployment to rise above NAIRU. We show that under nominal wage rigidity, long-run unemployment may rise drastically and at zero inflation, unemployment may be trapped at very high levels even if demands for wage redistribution tapers off. Under real wage rigidity, the economy may get trapped at high unemployment also at positive but low inflation rates irrespective of demand for wage redistribution has vanished or not. Thus, a period of wage redistribution may cause an economy of full real wage rigidity to get trapped at a high unemployment rate. A policy conclusion is that economies characterized by extensive wage rigidity should not target inflation at too low levels.

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28 pages, April 9, 2008

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