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Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployement


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)

March 6, 2008

MIT Department of Economics Working Paper No. 06-22
CFS Working Paper No. 2007/08

Abstract:     
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

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Date posted: July 31, 2006  

Suggested Citation

Blanchard, Olivier J. and Galí, Jordi, Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployement (March 6, 2008). MIT Department of Economics Working Paper No. 06-22; CFS Working Paper No. 2007/08. Available at SSRN: http://ssrn.com/abstract=920959 or http://dx.doi.org/10.2139/ssrn.920959

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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