Title: How do nominal and real rigidities interact? A tale of the second best
Abstract: This paper analyses the importance of real wage rigidities, in particular through their interaction with price stickiness, for optimal monetary policy in a calibrated small open economy DSGE model including oil in production and consumption. Blanchard and Gali (2007a) show real rigidities to introduce a trade-off between stabilising inflation and the welfare-relevant output gap. The present paper complements their findings by showing that the welfare cost 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, price stickiness can be welfare-enhancing.
Publication Year: 2007
Publication Date: 2007-10-31
Language: en
Type: preprint
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