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American Economic Journal: Macroeconomics: Vol. 2 No. 2 (April 2010)

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Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment

Article Citation

Blanchard, Olivier, and Jordi Galí. 2010. "Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment." American Economic Journal: Macroeconomics, 2(2): 1-30.

DOI: 10.1257/mac.2.2.1

Abstract

We construct a utility-based model of fluctuations with nominal rigidities and unemployment. We first show that under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. That property is also shown to hold, despite labor market frictions, in the decentralized equilibrium under flexible prices and wages. Inefficient unemployment fluctuations arise when we introduce real-wage rigidities. As a result, in the presence of staggered price setting by firms, the central bank faces a trade-off between inflation and unemployment stabilization, which depends on labor market characteristics. We draw the implications for optimal monetary policy. (JEL E12, E24, E52)

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Authors

Blanchard, Olivier (MIT)
Galí, Jordi (CREI, U Pompeu Fabra)

JEL Classifications

E12: General Aggregative Models: Keynes; Keynesian; Post-Keynesian
E24: Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital
E52: Monetary Policy

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American Economic Journal: Macroeconomics


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