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

42 Pages Posted: 21 Mar 2008 Last revised: 3 Jul 2010

See all articles by Olivier J. Blanchard

Olivier J. Blanchard

National Bureau of Economic Research (NBER); Peter G. Peterson Institute for International Economics

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)

Date Written: March 2008

Abstract

We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation tradeoff 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 unemployment. 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.

Suggested Citation

Blanchard, Olivier J. and Gali, Jordi, Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployment (March 2008). NBER Working Paper No. w13897. Available at SSRN: https://ssrn.com/abstract=1112009

Olivier J. Blanchard (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
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)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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