Nominal v. Real Wage Rigidities in New Keynesian Models with Hiring Costs: A Bayesian Evaluation
35 Pages Posted: 25 Oct 2007 Last revised: 30 Sep 2011
Date Written: October 16, 2009
The introduction of labor market frictions into the New Keynesian DSGE model solves some of the main drawbacks of the baseline framework. In this paper we show that this extended model, by assuming real wage rigidities, fails to replicate the correct wage dynamics and the observed negative conditional correlation between supply shocks and employment, known as "productivity-employment puzzle". We then show that these empirical limitations can be overcome by replacing real wage rigidities with nominal wage rigidities, without discarding other appealing features of the model. By adopting a Bayesian perspective, we estimate the dynamic properties of the model with real wage rigidities and confront them with those of the model with nominal wage rigidities, concluding that there is decisive evidence in favor of the latter.
Keywords: New Keynesian model, labor market frictions, unemployment, sticky prices, real wage rigidities, nominal wage rigidities, divine coincidence, technology shock, bayesian estimation
JEL Classification: E24, E32, C11
Suggested Citation: Suggested Citation