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http://ssrn.com/abstract=842285
 
 

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Real Wage Rigidities and the New Keynesian Model


Olivier J. Blanchard


International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Jordi Galí


Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

October 31, 2005

MIT Department of Economics Working Paper No. 05-28
FRB Boston Working Paper No. 05-14

Abstract:     
Most central banks perceive a trade-off between stabilizing inflation and stabilizing the gap between output and desired output. However, the standard new Keynesian framework implies no such trade-off. In that framework, stabilizing inflation is equivalent to stabilizing the welfare-relevant output gap. In this paper, we argue that this property of the new Keynesian framework, which we call the divine coincidence, is due to a special feature of the model: the absence of non trivial real
imperfections.

We focus on one such real imperfection, namely, real wage rigidities. When the baseline new Keynesian model is extended to allow for real wage rigidities, the divine coincidence disappears, and central banks indeed face a trade-off between stabilizing inflation and stabilizing the welfare-relevant output gap. We show that not only does the extended model have more realistic normative implications, but it also has appealing positive properties. In particular, it provides a natural interpretation for the dynamic inflation - unemployment relation found in the data.

Number of Pages in PDF File: 37

Keywords: oil price shocks, inflation targeting, monetary policy, inflation inertia

JEL Classification: E32, E50

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Date posted: November 7, 2005  

Suggested Citation

Blanchard, Olivier J. and Galí, Jordi, Real Wage Rigidities and the New Keynesian Model (October 31, 2005). MIT Department of Economics Working Paper No. 05-28; FRB Boston Working Paper No. 05-14. Available at SSRN: http://ssrn.com/abstract=842285 or http://dx.doi.org/10.2139/ssrn.842285

Contact Information

Olivier J. Blanchard (Contact Author)
International Monetary Fund (IMF) ( email )
700 19th Street, N.W.
Washington, DC 20431
United States
202 623 7825 (Phone)
202 623 7271 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Jordi Gali
Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )
Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2754 (Phone)
+34 93 542 1746 (Fax)
HOME PAGE: http://www.econ.upf.es/~gali
Massachusetts Institute of Technology (MIT) - Department of Economics ( email )
50 Memorial Drive
Cambridge, MA 02142
United States
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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