How Do Nominal and Real Rigidities Interact? A Tale of the Second Best |
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| Authors: | ROMAIN DUVAL LUKAS VOGEL |
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| Institution: | Romain Duval is Head of the Structural Surveillance Division at the OECD Economics Department, currently on leave at the IMF (E‐mail: rduval@imf.org). Lukas Vogel is an Economist at the Directorate General Economic and Financial Affairs, European Commission, Brussels (E‐mail: lukas.vogel@ec.europa.eu). |
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| Abstract: | This paper analyzes the importance of real wage rigidities, in particular through their interaction with price stickiness, in a New Keynesian model. Real wage rigidities result from a combination of staggered wage setting and partial indexation of nonreset wages to past inflation. Blanchard and Galí (2007) show real rigidities to introduce a trade‐off between stabilizing inflation and the welfare‐relevant output gap. The present paper complements their findings by showing that the welfare costs 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, higher price stickiness can be welfare enhancing. |
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| Keywords: | E30 F41 Q43 DSGE model price stickiness real wage rigidity optimal policy |
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