Optimal Monetary Policy with Staggered Wage and Price Contracts

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 place substantial weight on the output gap as well as price inflation are nearly optimal.

The Aggregate Implications of Regional Business Cycles

“…Each island is populated by a continuum of households indexed by j ∈ [0 1] who supply a differentiated labor service N kt (j) as in Erceg, Henderson, and Levin (2000). House-holds maximize the utility function…”

“…Also, as in Erceg, Henderson, and Levin (2000), we assume the existence of a large number of competitive labor agencies that buy all forms of differentiated labor services and transform them into homogeneous labor services, which they then sell for price W kt . Their profit maximization problem is…”

Overaccumulation, Interest, and Prices

“…The household enters into each period with real financial securities A t which serve as deposits with the financial intermediary, and nominal bonds B n t , earning risk-free gross real rate of return R a t and risk-free gross nominal rate of return R n t , respectively, receiving nominal wage W h t for supplying hours N h t to the labor union, and receiving a share of real profits from the capital-producers, goods-producers, financial intermediary, labor union, and employment agency, denoted collectively as 4 Schmitt-Grohé and Uribe (2006). show this decentralization yields a wage Phillips curve that is identical to that from theErceg, Henderson, and Levin (2000) model up to a log-linear approximation.…”

The Output and Welfare Effects of Government Spending Shocks Over the Business Cycle

“…This assumption on the separability of labor is common and facilitates the introduction of Calvo (1983) style staggered wage setting. When combined with perfect insurance across households, as in Erceg et al (2000), it implies that households will be identical along all margins except for labor supply and wages. As such, when writing out the household's problem, we will omit dependence on h with the exception of labor market variables.…”