Scandinavian Working Papers in Economics
Working Paper Series,
Uppsala University, Department of Economics
No 2007:15: Optimal Monetary Policy under Downward Nominal Wage Rigidity
Mikael Carlsson () and Andreas Westermark ()
Additional contact information
Mikael Carlsson: Research Department, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Andreas Westermark: Department of Economics, Postal: Uppsala University, 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
52 pages, April 10, 2007
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