How do nominal and real rigidities interact? A tale of the second best

Duval, Romain and Vogel, Lukas (2007): How do nominal and real rigidities interact? A tale of the second best.

Abstract

This paper analyses the importance of real wage rigidities, in particular through their interaction with price stickiness, for optimal monetary policy in a calibrated small open economy DSGE model including oil in production and consumption. Blanchard and Galí (2007a) show real rigidities to introduce a trade-off between stabilising inflation and the welfare-relevant output gap. The present paper complements their findings by showing that the welfare cost 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, price stickiness can be welfare-enhancing.

• Item Type: MPRA Paper
• Language: English
• Keywords: DSGE model, price stickiness, real wage rigidity, oil price shocks
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E30 - General; D - Microeconomics > D6 - Welfare Economics > D60 - General

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