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Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment

Author(s)
Blanchard, Olivier Jean; Gali, Jordi
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Abstract
We construct a utility-based model of fluctuations with nominal rigidities and unemployment. We first show that under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. That property is also shown to hold, despite labor market frictions, in the decentralized equilibrium under flexible prices and wages. Inefficient unemployment fluctuations arise when we introduce real-wage rigidities. As a result, in the presence of staggered price setting by firms, the central bank faces a trade-off between inflation and unemployment stabilization, which depends on labor market characteristics. We draw the implications for optimal monetary policy.
Date issued
2010-04
URI
http://hdl.handle.net/1721.1/71906
Department
Massachusetts Institute of Technology. Department of Economics
Journal
American Economic Journal: Macroeconomics
Publisher
American Economic Association
Citation
Blanchard, Olivier, and Jordi Galí. 2010. "Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment." American Economic Journal: Macroeconomics, 2(2): 1–30. Copyright 2010 American Economic Association.
Version: Final published version
ISSN
1945-7715

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