American Economic Review: Vol. 101 No. 4 (June 2011)


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The Inflation-Output Trade-Off with Downward Wage Rigidities

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Benigno, Pierpaolo, and Luca Antonio Ricci. 2011. "The Inflation-Output Trade-Off with Downward Wage Rigidities." American Economic Review, 101(4): 1436-66.

DOI: 10.1257/aer.101.4.1436


The macroeconomic implications of downward nominal wage rigidities are analyzed via a dynamic stochastic general equilibrium model featuring aggregate and idiosyncratic shocks. A closed-form solution for a long-run Phillips curve relates average output gap to average wage inflation: it is virtually vertical at high inflation and flattens at low inflation. Macroeconomic volatility shifts the curve outwards and reduces output. The results imply that stabilization policies play an important role, and that optimal inflation may be positive and differ across countries with different macroeconomic volatility. Results are robust to relaxing the wage constraint, for example, when large idiosyncratic shocks arise. (JEL E23, E24, E31, E63)

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Benigno, Pierpaolo (LUISS U "Guido Carli", Rome and EIEF)
Ricci, Luca Antonio (IMF)

JEL Classifications

E23: Macroeconomics: Production
E24: Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital
E31: Price Level; Inflation; Deflation
E63: Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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