Optimal Monetary Policy with Staggered Wage and Price Contracts

40 Pages Posted: 11 Sep 2000

See all articles by Christopher J. Erceg

Christopher J. Erceg

Board of Governors of the Federal Reserve System

Dale W. Henderson

Federal Reserve Board

Andrew T. Levin

affiliation not provided to SSRN

Date Written: July 1999

Abstract

We formulate an optimizing-agent model in which both labor and product markets exhibit monopolistic competition and staggered nominal contracts. The unconditional expectation of average household utility can be expressed in terms of the unconditional variances of the output gap, price inflation, and wage inflation. Monetary policy cannot replicate the Pareto-optimal equilibrium that would occur under completely flexible wages and prices; that is, the model exhibits a tradeoff between stabilizing the output gap, price inflation, and wage inflation. The Pareto optimum is only attainable if either wages or prices are completely flexible. For reasonable calibrations of the model, we characterize the optimal policy rule. Furthermore, strict price inflation targeting is clearly suboptimal, whereas rules that also respond to either the output gap or wage inflation are nearly optimal.

Keywords: inflation targeting, sticky wages, sticky prices, staggered contracts

JEL Classification: E52, E31, E32

Suggested Citation

Erceg, Christopher J. and Henderson, Dale W. and Levin, Andrew, Optimal Monetary Policy with Staggered Wage and Price Contracts (July 1999). International Finance Working Paper No. 640. Available at SSRN: https://ssrn.com/abstract=231785 or http://dx.doi.org/10.2139/ssrn.231785

Christopher J. Erceg (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2575 (Phone)
202-736-5638 (Fax)

Dale W. Henderson

Federal Reserve Board ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2343 (Phone)
202-736-5638 (Fax)

Andrew Levin

affiliation not provided to SSRN

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