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Imperfect credibility, sticky wages, and welfare

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journal contribution
posted on 2023-06-10, 01:09 authored by Ricardo Nunes, Donghyun Park, Luca Rondina
This paper studies optimal monetary policy under imperfect credibility in a New Keynesian model with staggered price and wage setting. In our imperfect credibility framework, the central bank commits to a policy plan but occasionally reneges on past promises with a given common knowledge probability. We find that the welfare gains from increasing credibility are approximately linear on the initial credibility level. We also find that the output-inflation stabilisation trade-off is nonmonotonic as higher credibility does not always reduce output volatility. The variance decomposition shows that wage markup shocks are the main driver of economic fluctuations and that these shocks are better contained, even in relative terms, when credibility is high. We then show that the degree of credibility impacts the effect of wage flexibility on welfare. When credibility is low, monetary policy is less potent and the economy can experience a feedback loop between wage volatility and price volatility. We show, though, that once wage markup shocks are taken into account, wage flexibility is usually welfare improving.

History

Publication status

  • Published

File Version

  • Accepted version

Journal

Journal of Macroeconomics

ISSN

0164-0704

Publisher

Elsevier

Volume

70

Page range

1-19

Article number

a103363

Department affiliated with

  • Economics Publications

Full text available

  • Yes

Peer reviewed?

  • Yes

Legacy Posted Date

2021-09-27

First Open Access (FOA) Date

2022-08-31

First Compliant Deposit (FCD) Date

2021-09-24

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