Real wages and monetary policy: A DSGE approach

Perry, Bryan and Phillips, Kerk L. and Spencer, David E. (2012): Real wages and monetary policy: A DSGE approach.

Abstract

Economists have long investigated the cyclical behavior of real wages in order to draw inferences regarding the relative stickiness of prices and wages. Recent studies have adopted techniques intended to identify monetary shocks and examined the response of real wages and output or employment to such shocks. A finding that real wages are procyclical in response to a positive monetary policy shock, for example, is taken as evidence that prices are stickier than wages. In this paper, we show that factors other than wage and price stickiness affect the response of real wages to a monetary policy shock. Accordingly, examining the response of real wages is not enough to sort out the relative stickiness of prices and wages. We use two prominent DSGE models to help us address this issue. These models incorporate both sticky wages and prices but in different ways. The first model (Huang, Liu, and Phaneuf, American Economic Review, 2004) is relatively simple and is not intended for policy analysis. Its relative simplicity allows us to approach the issues both analytically and through simulations. The second model (Smets and Wouters, American Economic Review, 2007) is a relatively complex model of the U.S. economy with many frictions and intended to be useful for policy analysis. Because of its complexity, we must rely principally on simulation exercises. Using these models we offer robust evidence that the real wage response to monetary policy is affected in important ways by properties of the economy other than stickiness of wages and prices, such as the importance of intermediate goods in the production process and the size of key elasticities. Consequently, we cannot appropriately infer the relative stickiness of wages and prices from examining only the response of real wages to a monetary policy shock.

• Item Type: MPRA Paper
• Language: English
• Keywords: real wages, monetary policy, DSGE models
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E10 - General

References

Ball, Laurence, N. Gregory Mankiw, and David Romer. “The new Keynesian Economics and the Output-Inflation Tradeoff.” Brookings Papers on Economic Activity, 1, 1988, 1-65.

Calvo, Guillermo A. “Staggered Prices in a Utility-Maximizing Framework.” Journal of Monetary Economics, 12.3, September 1983, 383-98.

Christiano, Lawrence, Martin Eichenbaum and Charles Evans. “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy”, Journal of Political Economy 113.1, February 2005, 1-45.

Dixon, Huw, and Engin Kara. “How to Compare Taylor and Calvo Contracts: A Comment on Michael Kiley.” Journal of Money, Credit, and Banking, 38.4, June 2006, 1119-26.

Dunlop, John T. “The Movement of Real and Money Wage Rates.” Economic Journal, September 1938, 413-34.

Fischer, Stanley. “Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule.” Journal of Political Economy, February 1977, 191-205.

Fischer, Stanley. "Recent Developments in Macroeconomics," Economic Journal, 98.391 June 1988, 294-339.

Fleischman, Charles A. “The Causes of Business Cycles and the Cyclicality of Real Wages.” Journal of Economic Literature, October 1999-53. Board of Governors of the Federal Reserve System (U.S.).

Gamber, Edward N., and Frederick L. Joutz. “The Dynamic Effects of Aggregate Demand and Supply Disturbances: Comment.” American Economic Review, 83.5, December 1993, 1387-93.

Huang, Kevin X. D., Zheng Liu, and Louis Phaneuf. “Why Does Cyclical Behavior of Real Wages Change Over Time?” American Economic Review, 94.4, September 2004, 836-56.

Kimball, Miles. “The Quantitative Analytics of the Basic Neomonetarist Model," Journal of Money, Credit and Banking, November 1995, 27.4, 1241-77.

Mankiw, N. Gregory. “Comment.” NBER Macroeconomics Annual, 2, 1987, 105-10.

McCallum, Bennet T. “On ‘Real’ and ‘Sticky-Price’ Theories of the Business Cycle.” Journal of Money, Credit, and Banking, November 1986, 397-414.

Smets, Frank, and Rafael Wouters. “Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach.” American Economic review, 97.3, June 2007, 586-606.

Spencer, David E. “The Relative Stickiness of Wages and Prices.” Economic Inquiry, 36.1, January 1998, 120-137.

Sumner, Scott, and Stephen Silver. “Real Wages, Employment, and the Phillips Curve.” Journal of Political Economy, June 1989, 706-20.

Taylor, John. “Aggregate Dynamics and Staggered Contracts.” Journal of Political Economy, 88.1, February 1980, 1-23.

Taylor, John. “Staggered Price and Wage Setting in Macroeconomics.” in J.B. Taylor and M. Woodford eds., Handbook of Macroeconomics, 1999, chapter 15, 1341-1397, Elsevier, New York.