Rule-of-Thumb Consumers Meet Sticky Wages

Authors


  • This is a substantially revised version of the first chapter of my PhD dissertation. I thank Guido Ascari and Patrizio Tirelli for guidance. I would also like to thank Florin Bilbiie, Enzo Dia, Giovanni Di Bartolomeo, Federico Etro, Lorenzo Forni, Glenn Harma, Enrico Longoni, Tiziano Ropele, Lorenza Rossi, two anonymous referees, and seminar participant at the University of Milano Bicocca, the Bank of Finland, and the Bank of Italy for useful suggestions.

Abstract

It has been argued that rule-of-thumb consumers substantially alter the determinacy properties of interest rate rules and the dynamics of an otherwise standard New Keynesian model. In this paper, we show that nominal-wage stickiness helps to restore standard results. The key findings are that when wages are sticky: (i) the Taylor Principle is re-established as the necessary condition for equilibrium determinacy, and (ii) consumption rises in response to an innovation in government spending if monetary policy is characterized by interest rate smoothing and by a moderately anti-inflationary stance. Our results help to explain the reduction in the expansionary effects of fiscal shocks observed in the United States since 1980.

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