Imperfect credibility, sticky wages, and welfare

Nunes, Ricardo, Park, Donghyun and Rondina, Luca (2021) Imperfect credibility, sticky wages, and welfare. Journal of Macroeconomics, 70. a103363 1-19. ISSN 0164-0704

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Abstract

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.

Item Type: Article
Keywords: Imperfect credibility, Monetary policy, Wage flexibility
Schools and Departments: University of Sussex Business School > Economics
SWORD Depositor: Mx Elements Account
Depositing User: Mx Elements Account
Date Deposited: 27 Sep 2021 07:35
Last Modified: 27 Sep 2021 07:45
URI: http://sro.sussex.ac.uk/id/eprint/101908

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