How Do Nominal and Real Rigidities Interact? A Tale of the Second Best

Munich Personal RePEc Archive Paper No. 7282

27 Pages Posted: 24 Apr 2008

See all articles by Romain Duval

Romain Duval

Organization for Economic Co-Operation and Development (OECD)

Lukas Vogel

European Union - European Commission

Date Written: October 31, 2007

Abstract

This paper analyses the importance of real wage rigidities, in particular through their interaction with price stickiness, for optimal monetary policy in a calibrated small open economy DSGE model including oil in production and consumption. Blanchard and Galí (2007a) show real rigidities to introduce a trade-off between stabilising inflation and the welfare-relevant output gap. The present paper complements their findings by showing that the welfare cost of real rigidities can be substantial compared to nominal frictions. In a typical "tale of the second best", we also show that in the presence of real wage rigidities, price stickiness can be welfare-enhancing.

Keywords: DSGE model, price stickiness, real wage rigidity, oil price shocks

JEL Classification: E30, F41, Q43

Suggested Citation

Duval, Romain and Vogel, Lukas, How Do Nominal and Real Rigidities Interact? A Tale of the Second Best (October 31, 2007). Munich Personal RePEc Archive Paper No. 7282, Available at SSRN: https://ssrn.com/abstract=1124803 or http://dx.doi.org/10.2139/ssrn.1124803

Romain Duval

Organization for Economic Co-Operation and Development (OECD) ( email )

2 rue Andre Pascal
Paris Cedex 16, 75775
France

Lukas Vogel (Contact Author)

European Union - European Commission ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium

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