Real Wage Rigidities and the Cost of Disinflations

Authors


  • We would like to thank Jean-Pascal Bénassy, Jordi Galí, Paul J. Kramer, Tiziano Ropele, Leo von Thadden, Roland Winkler, the participants of the IfW Symposium on “The Phillips Curve and the Natural Rate of Unemployment,” the Bundesbank-IWH workshop on “Monetary and Financial Economics,” the Annual Meeting of the German Economic Association, and the European Meeting of the Econometric Society, and two anonymous referees for very helpful comments.

Abstract

This paper analyzes the cost of disinflations under real wage rigidities in a micro-founded New Keynesian model. The conventional view is that real wage rigidities can be a useful mechanism to generate a slump in output after a credible disinflationary policy because they prevent the immediate adjustment of inflation. This view is flawed, since it depends on analyzing the model in a linearized framework. Once nonlinearities are taken into account, the results change both qualitatively and quantitatively. Disinflations actually lead to a permanently higher level of output, and real wage rigidities increase the output during the adjustment to the new steady state.

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