Endogenous Growth, Downward Wage Rigidities and Optimal Inflation

By Mirko Abbritti, Agostino Consolo, Sebastian Weber

August 6, 2021

Preview Citation

Format: Chicago

Mirko Abbritti, Agostino Consolo, and Sebastian Weber. Endogenous Growth, Downward Wage Rigidities and Optimal Inflation, (USA: International Monetary Fund, 2021) accessed November 8, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

Standard New Keynesian (NK) models feature an optimal inflation target well below two percent, limited welfare losses from business cycle fluctuations and long-term monetary neutrality. We develop a NK framework with labour market frictions, endogenous productivity and downward wage rigidity (DWR) which challenges these results. The model features a non-vertical long-run Phillips curve between inflation and unemployment and a trade-off between price distortions and output hysteresis that change the welfare-maximizing inflation level. For a plausible set of parameters, the optimal inflation target is in excess of two percent, a target value commonly used across central banks. Deviations from the optimal target carry welfare costs multiple times higher than in traditional NK models. The main reason is that endogenous growth and DWR generate asymmetric and hysteresis effects on unemployment and output. Price level targeting or a Taylor-rule responding to the unemployment rate can handle better the asymmetric and hysteresis effects in our model and deliver significant welfare gains. Our results are robust to the inclusion of the effective lower bound on the monetary policy interest rate.

Subject: Inflation, Inflation targeting, Labor, Monetary policy, Prices, Wage adjustments, Wage rigidity, Wages

Keywords: Global, Inflation, Inflation level, Inflation targeting, Invariance hypothesis, NK model, Target carry welfare cost, Target value, Wage adjustments, Wage rigidity, Wages

Publication Details

Pages:

49
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2021/208
Stock No:

WPIEA2021208
ISBN:

9781513583983
ISSN:

1018-5941

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