Nominal Wage Contracts, Adjustment Costs and Real Persistence of Monetary Shocks

This paper describes a model in which monetary shocks have persistent real effects. Starting from the limited participation model of Christiano (1991) with capital adjustment costs as suggested by Dow (1995) it is confirmed that costs of equipment installation and restrictions on consumer portfolio choices alone cannot account for the observed effects of monetary policy. However, after introducing nominal wage contracts as a third friction, the model generates real effects of monetary shocks. It is shown that these real effects are highly persistent for a realistic size of adjustment costs and strongly autocorrelated money growth shocks which are typical for Europe.