Optimal Monetary Policy with Staggered Wage and Price Contracts
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Optimal Monetary Policy with Staggered Wage and Price Contracts
Erceg, Christopher J. | Henderson, Dale W. | Levin, Andrew T.
Credit and Capital Markets – Kredit und Kapital, Vol. 52 (2019), Iss. 4 : pp. 537–571
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Prof. Dr. Christopher J. Erceg, National Bureau of Economic Research, Federal Reserve Board, 1050 Massachusetts Ave, Cambridge, MA 02138, USA
Prof. Dr. Dale W. Henderson, Georgetown University, General Economics, 3700 O St NW, Washington, DC 20057, USA
Prof. Dr. Andrew T. Levin. Dartmouth College, Department of Economics, 322 Rockefeller Hall, Hanover, NH 03755–3514, USA
References
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Aizenman, J./Frenkel, J. A. (1986): Wage indexation, supply shocks, and monetary policy in a small open economy, In: Edwards, S., Ahamed, L. (Eds.), Economic Adjustment and Exchange Rate Changes in Developing Countries. University of Chicago Press, Chicago.
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Blanchard, O. J./Kiyotaki, N. (1987): Monopolistic competition and the effects of aggregate demand. American Economic Review 77 (4), pp. 647–666.
Google Scholar -
Bryant, R./Hooper, P./Mann, Z. C. (1993): Evaluating Policy Regimes: New Research in Empirical Macroeconomics. Brookings Institution, Washington, D.C.
Google Scholar -
Calvo, G. (1983): Staggered prices in a utility maximizing framework. Journal of Monetary Economics 12, pp. 383–398.
Google Scholar -
Canzoneri, M. B. (1980): Labor contracts and monetary policy. Journal of Monetary Economics 6, pp. 241–245.
Google Scholar -
Cuddington, J. T./Johansson, P.-O./Löfgren, K.-G. (1984): Disequilibrium Macroeconomics in Open Economies. Basil Blackwell, Oxford.
Google Scholar -
Dixit, A. K./Stiglitz, J. (1977): Monopolistic competition and optimum product diversity. American Economic Review 67, pp. 297–308.
Google Scholar -
Dotsey, M./King, R. G./Wolman, A. L. (1997): State dependent pricing and dynamics of business cycles. Working paper No. 97-2, Federal Reserve Bank of Richmond.
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Erceg, C. J. (1997): Nominal wage rigidities and the propagation of monetary disturbances. International Finance Discussion Papers, No. 590, Federal Reserve Board.
Google Scholar -
Erceg, C. J./Henderson/D. W., Levin, A. T. (1998): Tradeoffs between inflation and output-gap variances in a optimizing-agent model. International Finance Discussion Papers, No. 627, Federal Reserve Board.
Google Scholar -
Friedman, B. (1999): Comment. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 398–402.
Google Scholar -
Goodfriend, M./King, R. (1997): The new neoclassical synthesis and the role of monetary policy. In: Bernanke, B. S., Rotemberg, J. J. (Eds.), NBER Macroeconomics Annual 1997. MIT Press, Cambridge, pp. 233–283.
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Gray, J. (1978): On indexation and contract length. Journal of Political Economy 86, pp. 1–18.
Google Scholar -
Henderson, D./McKibbin, W. (1993): A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence. Carnegie-Rochester Series on Public Policy 39, pp. 221–317.
Google Scholar -
Ireland, P. N. (1997): A small structural, quarterly model for monetary policy evaluation. Carnegie- Rochester Series on Public Policy 47, pp. 83–108.
Google Scholar -
Kerr, W./King, R. G. (1996): Limits on interest rate rules in the IS model. Federal Reserve Bank of Richmond Economic Quarterly 82, pp. 47–75.
Google Scholar -
Keynes, J. M. (1935): The General Theory of Employment, Interest, and Money. Harcourt, Brace, and World, New York.
Google Scholar -
Kiley, M. T. (1998): Monetary policy under neoclassical and new-Keynesian Phillips curves, with an application to price level and inflation targeting. Finance and Economics Discussion Series No. 1998-27, Federal Reserve Board.
Google Scholar -
Kim, J. (2000): Constructing and estimating a realistic optimizing model of monetary policy. Journal of Monetary Economics 45, pp. 329–359.
Google Scholar -
Kimball, M. S. (1995): The quantitative analysis of the basic neomonetarist model. Journal of Money, Credit, and Banking 27, pp. 1241–1277.
Google Scholar -
King, R. G./Wolman, A. L. (1999): What should the monetary authority do when prices are sticky?. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 349–398.
Google Scholar -
Kollmann, R. (1997): The exchange rate in a dynamic-optimizing current account model with nominal rigidities: a quantitative investigation. Working paper, International Monetary Fund.
Google Scholar -
Levin, A. (1989): The theoretical and empirical relevance of staggered wage contract models. Ph.D. Dissertation, Stanford University.
Google Scholar -
Levin, A./Wieland, V./Williams, J. C. (1999): Robustness of simple monetary policy rules under model uncertainty. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 263–299.
Google Scholar -
McCallum, B. T./Nelson, E. (1999): Performance of operational policy rules in an estimated semiclassical structural model. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 349–398.
Google Scholar -
Phelps, E. S./Taylor, J. B. (1977): Stabilizing powers of monetary policy under rational expectations. Journal of Political Economy 85, pp. 163–190.
Google Scholar -
Rotemberg, J. J. (1996): Prices, output, and hours: an empirical analysis based on a sticky price model. Journal of Monetary Economics 37, pp. 505–533.
Google Scholar -
Rotemberg, J. J./Woodford, M. (1997): An optimization-based econometric framework for the evaluation of monetary policy. In: Bernanke, B. S., Rotemberg, J. J. (Eds.), NBER Macroeconomics Annual 1997. MIT Press, Cambridge, pp. 297–346.
Google Scholar -
Rotemberg, J. J./Woodford, M. (1999): Interest-rate rules in an estimated sticky price model. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 57–119.
Google Scholar -
Rudebusch, G. D./Svensson, L. E.O (1999): Policy rules for inflation targeting. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 203–246.
Google Scholar -
Solow, R./Stiglitz, J. (1968): Output, employment, and wages in the short run. Quarterly Journal of Economics 82, pp. 537–560.
Google Scholar -
Taylor, J. (1979): Staggered contracts in a macro model. American Economic Review 69, pp. 108–113.
Google Scholar -
Taylor, J. (1980): Aggregate dynamics and staggered contracts. Journal of Political Economy 88, pp. 1–24.
Google Scholar -
Taylor, J. B. (1993): Discretion versus policy rules in practice. Carnegie-Rochester Series on Public Policy 39, pp. 195–214.
Google Scholar -
Tetlow, R./von zur Muehlen, P. (1996): Monetary policy rules in a small forward-looking maco model. Processed, Federal Reserve Board.
Google Scholar -
Tetlow, R./von zur Muehlen, P. (1999): Simplicity versus optimality: the choice of monetary policy rules when agents must learn, Finance and Economics Discussion Series No. 1999-10, Federal Reserve Board.
Google Scholar -
Williams, J. C. (1999): Simple rules for monetary policy. Finance and Economics Discussion Series No. 1999-12, Federal Reserve Board.
Google Scholar -
Woodford, M. (1996): Control of the public debt: a requirement for price stability?. NBER Working Paper 5684, National Bureau of Economic Research.
Google Scholar -
Yun, T. (1996): Nominal price rigidity, money supply endogeneity, and business cycles. Journal of Monetary Economics 37, pp. 345–370.
Google Scholar -
Aizenman, J./Frenkel, J. A. (1986): Wage indexation, supply shocks, and monetary policy in a small open economy, In: Edwards, S., Ahamed, L. (Eds.), Economic Adjustment and Exchange Rate Changes in Developing Countries. University of Chicago Press, Chicago.
Google Scholar -
Anderson, G. S./Moore, G. (1985): A linear algebraic procedure for solving linear perfect foresight models. Economic Letters 17, pp. 247–252.
Google Scholar -
Barro, R. J. (1977): Long-term contracting, sticky prices, and monetary policy. Journal of Monetary Economics 3, pp. 305–316.
Google Scholar -
Blanchard, O. (1997): Comment, In: NBER Macroeconomics Annual 1997. MIT Press, Cambridge, MA, pp. 289–295.
Google Scholar -
Blanchard, O./Kahn, C. M. (1980): The solution of linear difference models under rational expectations. Econometrica 48, pp. 1305–1311.
Google Scholar -
Blanchard, O. J./Kiyotaki, N. (1987): Monopolistic competition and the effects of aggregate demand. American Economic Review 77 (4), pp. 647–666.
Google Scholar -
Bryant, R./Hooper, P./Mann, Z. C. (1993): Evaluating Policy Regimes: New Research in Empirical Macroeconomics. Brookings Institution, Washington, D.C.
Google Scholar -
Calvo, G. (1983): Staggered prices in a utility maximizing framework. Journal of Monetary Economics 12, pp. 383–398.
Google Scholar -
Canzoneri, M. B. (1980): Labor contracts and monetary policy. Journal of Monetary Economics 6, pp. 241–245.
Google Scholar -
Cuddington, J. T./Johansson, P.-O./Löfgren, K.-G. (1984): Disequilibrium Macroeconomics in Open Economies. Basil Blackwell, Oxford.
Google Scholar -
Dixit, A. K./Stiglitz, J. (1977): Monopolistic competition and optimum product diversity. American Economic Review 67, pp. 297–308.
Google Scholar -
Dotsey, M./King, R. G./Wolman, A. L. (1997): State dependent pricing and dynamics of business cycles. Working paper No. 97-2, Federal Reserve Bank of Richmond.
Google Scholar -
Erceg, C. J. (1997): Nominal wage rigidities and the propagation of monetary disturbances. International Finance Discussion Papers, No. 590, Federal Reserve Board.
Google Scholar -
Erceg, C. J./Henderson/D. W., Levin, A. T. (1998): Tradeoffs between inflation and output-gap variances in a optimizing-agent model. International Finance Discussion Papers, No. 627, Federal Reserve Board.
Google Scholar -
Friedman, B. (1999): Comment. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 398–402.
Google Scholar -
Goodfriend, M./King, R. (1997): The new neoclassical synthesis and the role of monetary policy. In: Bernanke, B. S., Rotemberg, J. J. (Eds.), NBER Macroeconomics Annual 1997. MIT Press, Cambridge, pp. 233–283.
Google Scholar -
Gray, J. (1978): On indexation and contract length. Journal of Political Economy 86, pp. 1–18.
Google Scholar -
Henderson, D./McKibbin, W. (1993): A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence. Carnegie-Rochester Series on Public Policy 39, pp. 221–317.
Google Scholar -
Ireland, P. N. (1997): A small structural, quarterly model for monetary policy evaluation. Carnegie- Rochester Series on Public Policy 47, pp. 83–108.
Google Scholar -
Kerr, W./King, R. G. (1996): Limits on interest rate rules in the IS model. Federal Reserve Bank of Richmond Economic Quarterly 82, pp. 47–75.
Google Scholar -
Keynes, J. M. (1935): The General Theory of Employment, Interest, and Money. Harcourt, Brace, and World, New York.
Google Scholar -
Kiley, M. T. (1998): Monetary policy under neoclassical and new-Keynesian Phillips curves, with an application to price level and inflation targeting. Finance and Economics Discussion Series No. 1998-27, Federal Reserve Board.
Google Scholar -
Kim, J. (2000): Constructing and estimating a realistic optimizing model of monetary policy. Journal of Monetary Economics 45, pp. 329–359.
Google Scholar -
Kimball, M. S. (1995): The quantitative analysis of the basic neomonetarist model. Journal of Money, Credit, and Banking 27, pp. 1241–1277.
Google Scholar -
King, R. G./Wolman, A. L. (1999): What should the monetary authority do when prices are sticky?. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 349–398.
Google Scholar -
Kollmann, R. (1997): The exchange rate in a dynamic-optimizing current account model with nominal rigidities: a quantitative investigation. Working paper, International Monetary Fund.
Google Scholar -
Levin, A. (1989): The theoretical and empirical relevance of staggered wage contract models. Ph.D. Dissertation, Stanford University.
Google Scholar -
Levin, A./Wieland, V./Williams, J. C. (1999): Robustness of simple monetary policy rules under model uncertainty. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 263–299.
Google Scholar -
McCallum, B. T./Nelson, E. (1999): Performance of operational policy rules in an estimated semiclassical structural model. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 349–398.
Google Scholar -
Phelps, E. S./Taylor, J. B. (1977): Stabilizing powers of monetary policy under rational expectations. Journal of Political Economy 85, pp. 163–190.
Google Scholar -
Rotemberg, J. J. (1996): Prices, output, and hours: an empirical analysis based on a sticky price model. Journal of Monetary Economics 37, pp. 505–533.
Google Scholar -
Rotemberg, J. J./Woodford, M. (1997): An optimization-based econometric framework for the evaluation of monetary policy. In: Bernanke, B. S., Rotemberg, J. J. (Eds.), NBER Macroeconomics Annual 1997. MIT Press, Cambridge, pp. 297–346.
Google Scholar -
Rotemberg, J. J./Woodford, M. (1999): Interest-rate rules in an estimated sticky price model. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 57–119.
Google Scholar -
Rudebusch, G. D./Svensson, L. E.O (1999): Policy rules for inflation targeting. In: Taylor, J. (Ed.), Monetary Policy Rules. The University of Chicago Press, Chicago, pp. 203–246.
Google Scholar -
Solow, R./Stiglitz, J. (1968): Output, employment, and wages in the short run. Quarterly Journal of Economics 82, pp. 537–560.
Google Scholar -
Taylor, J. (1979): Staggered contracts in a macro model. American Economic Review 69, pp. 108–113.
Google Scholar -
Taylor, J. (1980): Aggregate dynamics and staggered contracts. Journal of Political Economy 88, pp. 1–24.
Google Scholar -
Taylor, J. B. (1993): Discretion versus policy rules in practice. Carnegie-Rochester Series on Public Policy 39, pp. 195–214.
Google Scholar -
Tetlow, R./von zur Muehlen, P. (1996): Monetary policy rules in a small forward-looking maco model. Processed, Federal Reserve Board.
Google Scholar -
Tetlow, R./von zur Muehlen, P. (1999): Simplicity versus optimality: the choice of monetary policy rules when agents must learn, Finance and Economics Discussion Series No. 1999-10, Federal Reserve Board.
Google Scholar -
Williams, J. C. (1999): Simple rules for monetary policy. Finance and Economics Discussion Series No. 1999-12, Federal Reserve Board.
Google Scholar -
Woodford, M. (1996): Control of the public debt: a requirement for price stability?. NBER Working Paper 5684, National Bureau of Economic Research.
Google Scholar -
Yun, T. (1996): Nominal price rigidity, money supply endogeneity, and business cycles. Journal of Monetary Economics 37, pp. 345–370.
Google Scholar
Abstract
We formulate an optimizing-agent model in which both labor and product markets exhibit monopolistic competition and staggered nominal contracts. The unconditional expectation of average household utility can be expressed in terms of the unconditional variances of the output gap, price inflation, and wage inflation. Monetary policy cannot achieve the Pareto-optimal equilibrium that would occur under completely flexible wages and prices; that is, the model exhibits a tradeoff in stabilizing the output gap, price inflation, and wage inflation. We characterize the optimal policy rule for reasonable calibrations of the model. We also find that strict price inflation targeting generates relatively large welfare losses, whereas several other simple policy rules perform nearly as well as the optimal rule.