Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployement
Olivier J. Blanchard
Peter G. Peterson Institute for International Economics; National Bureau of Economic Research (NBER)
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)
March 6, 2008
MIT Department of Economics Working Paper No. 06-22
CFS Working Paper No. 2007/08
We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation trade- off and for the conduct of monetary policy. We proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in un- employment. We show the role of labor market frictions and real wage rigidities in determining the effects of productivity shocks on unemployment. We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of labor market frictions and real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and its dependence on labor market characteristics. We draw the implications for optimal monetary policy.
Number of Pages in PDF File: 42
Keywords: New-Keynesian model, labor market frictions, search model, unemployment, sticky prices, real wage rigidities
JEL Classification: E32, E50
Date posted: July 31, 2006
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