The views that are expressed in the paper are those of the authors and do not necessarily reflect views of the OECD or the European Commission. We thank the editor Pok-sang Lam and two anonymous referees for very valuable comments and suggestions.
How Do Nominal and Real Rigidities Interact? A Tale of the Second Best
Article first published online: 19 SEP 2012
© 2012 The Ohio State University
Journal of Money, Credit and Banking
Volume 44, Issue 7, pages 1455–1474, October 2012
How to Cite
DUVAL, R. and VOGEL, L. (2012), How Do Nominal and Real Rigidities Interact? A Tale of the Second Best. Journal of Money, Credit and Banking, 44: 1455–1474. doi: 10.1111/j.1538-4616.2012.00540.x
- Issue published online: 19 SEP 2012
- Article first published online: 19 SEP 2012
- Received November 20, 2007; and accepted in revised form December 6, 2011.
- DSGE model;
- price stickiness;
- real wage rigidity;
- optimal policy
This paper analyzes the importance of real wage rigidities, in particular through their interaction with price stickiness, in a New Keynesian model. Real wage rigidities result from a combination of staggered wage setting and partial indexation of nonreset wages to past inflation. Blanchard and Galí (2007) show real rigidities to introduce a trade-off between stabilizing inflation and the welfare-relevant output gap. The present paper complements their findings by showing that the welfare costs of real rigidities can be substantial compared to nominal frictions. In a typical “tale of the second best,” we also show that in the presence of real wage rigidities, higher price stickiness can be welfare enhancing.