Asymmetric Inflation Expectations, Downward Rigidity of Wages, and Asymmetric Business Cycles

Abstract

Households typically know their nominal wages precisely, but only have a vague idea about he price of the goods and services they consume. Conditional on their nominal wage, this means that inflation is bad news and deflation is good news. If households face Knightian uncertainty about the price level, and they act to minimize their worst-case losses, they will react more strongly to inflationary news than to disinflationary news. This provides an explanation for downward wage rigidity. In such a world, household beliefs are asymmetric, and monetary policy has asymmetric effects on employment, output, and wage inflation.

Keywords: wage rigidity, downward wage rigidity, ambiguity, asymmetric business cycles, asymmetric expectations

JEL Classification: E4, E3, D8, J3