ECON 4325 Monetary Policy

Transcription

1 ECON 4325 Monetary Policy Lecture 12, spring 2013 Steinar Holden Rigid wages - sticky wages and prices (Gali ch 6 - not in detail) - downward nominal wage rigidity - monetary policy with large wage setters (Holden not in detail) 1

2 Gali Chapter 6 Sticky wages and prices Up till now: o Wages taken as given by households and firms o Wages flexible so as to clear labor market o Marginal product of labor = disutility of labor (i.e. employment at efficient level) Strong evidence that wages are rigid in nominal terms Wages are usually part of a long-term relationship between two parties o Wage rigidity may be due to explicit or implicit contract o Insurance for risk averse workers o Protect return of workers investment (avoid holdup problem) o I.e. not only distortion What are the implications of wage rigidity for monetary policy? 2

3 Model builds on Erceg, Henderson, Levin Each household supplies specialized labor services to firms (can also be interpreted as a union organizing all workers of one specific type) Households have some market/monopoly power in the labor market o Set wage for their labor type, but high wage leads to lower employment o Wage set as markup on MRS (disutility of labor measured in consumption units) => source of inefficiency in steady state; underemployment, not unemployment o Markup is lower, the more elastic the labor demand Full consumption risk sharing across households, so income dispersion does not affect other variables. o No effect of income distribution Calvo-assumption: Fraction (1-θ W ) allowed to change wage in every period 3

4 Otherwise the model as before (consumption and price setting) Optimal allocation will prevail under flexible prices and wages o Natural level of output o Natural rate of interest o Natural real wage Price and wage rigidity leads to distortions o Inefficient consumption pattern o Inefficient use of different types of labor As before no goods- or labor-type specific shocks => no need to change relative prices or wages o Zero price inflation will ensure optimal relative prices o Zero wage inflation will ensure optimal relative wages 4

5 With rigid prices and flexible wages Zero price inflation prevents distortions in relative prices Wages respond to ensure that real wage is flexible Divine coincidence holds in the absence of cost-push shocks: stabilizing price inflation is equivalent to stabilizing the welfare-relevant output gap, i.e. zero price inflation leads to zero output gap. 5

6 When both prices and wages are rigid Wages will no longer ensure an optimal real wage, implying that there will be a non-zero output gap even with zero price inflation => lead to inefficient fluctuations in average markup of prices over wages (source of inefficient fluctuations in output) plus - inefficient consumption pattern - inefficient use of different types of labor => optimal policy responds to a weighted average of price and wage inflation => optimal weight on wage inflation is increasing in wage stickiness 6

7 Price inflation function of output gap and real wage gap Wage inflation function of output gap and real wage gap Wage gap identity ω ω + π π ω w p n t t 1 t t t Dynamic IS equation Interest rate rule 7

8 Note 1) to the model 2) Extended Taylor principle Uniqueness requires (to avoid indeterminacy, assuming Φ y = 0) 8

9 Both wage and price rigidity Shock: Exogenous increase in quarterly interest rate of 0.25%; Shock persists with AR(1) coef = 0.5 9

10 Figure 6.3 Sticky wages and the effects of a monetary policy shock 10

11 Figure 6.4 The effects of a technology shock under optimal policy 11

12 Evaluation of simple rules Strict rules: zero wage /price/composite inflation Flexible rules: Interest respond to inflation target (i t = ρ+ 1.5π t ) Loss measured in percent of steady state consumption Sticky wages => important to stabilize wage inflation 12

13 Interaction between wage setting and monetary regime (not in Gali) Standard view: No long run link between real and nominal variables (classical dichotomy) Short run effects due to nominal rigidities Two challenges to the standard view: Downward nominal wage rigidity, DNWR o Too low inflation leads to excessive unemployment Strategic relationship between monetary policy and large wage setters o Strictness of monetary policy may affect the equilibrium rate of unemployment, and the coordination of wage setting 13

14 Downward nominal wage rigidity Considerable evidence that wages are rigid downwards in nominal terms Distribution of individual wage changes 14

15 Sources of DNWR Fairness Survey evidence: nominal wage cuts viewed as unfair even when same real wage cut would be viewed as fair if due to price increase (Shafir et al 1997, Bewley, 1999) Experimental evidence Fehr and Tyran (AER, 2001) Legal/contractual mechanism Nominal contracts can only be changed by mutual consent (MacLeod Malcomson, 1993, Holden, 1994) Firms must force workers/unions to accept wage cut by threats of layoffs, lock-out, closing down plant, etc These mechanisms are complementary 15

16 In long run equilibrium, the scope for wage inflation = price inflation + productivity growth If the scope for wage inflation is too small to allow for necessary changes in relative wages, downward nominal wage rigidity may bind and push up wages (increased wage pressure) o Workers have ceteris paribus a stronger bargaining position when they resist a nominal wage cut Increased wage pressure leads to higher equilibrium unemployment Highly relevant in the euro-area, where some countries have too high cost level, and need to improve their cost competitiveness 16

17 The standard model with no DNWR Real wage Wage curve Price curve N* Employment N Steady-state inflation has no effect on eq. employment Steinar Holden 8 17

18 DNWR and low steady-state inflation Real wage Wage curve, no inflation Wage curve, high inflation Price curve Under zero inflation, DNWR will bind in parts of the labour market, pushing wages up for some workers N L N H Employment N Steinar Holden 9 18

19 Inflation The long run Phillips-curve The vertical position of the downwardsloping part depends on productivity growth, cost-push shocks and the wage setting system U L U H Unemployment Steinar Holden 10 19

20 However, DNWR attenuates wage rises at low inflation Employers know that DNWR makes it difficult to cut wages in the future (Elsby, JME 2009) o Will attenuate wage increases so ast to reduce risk that DNWR binds in the future Makes inflation more stable when low o Reduces risk that e.g. oil price shocks feed into wage increases. o Complementary explanation by Blanchard & Riggi (2009): due to less wage indexation and more credible monetary policy 20

21 The interaction between the central bank and large wage setters a) Effect on equilibrium unemployment Bratsiotis and Martin (SJE, 1999), Soskice and Iversen (1998, QJE, 2000) Large wage setters set wages to balance the gain from higher wages against the cost in the form of lower employment A strict monetary regime makes employment more sensitive to the real wage (i.e. higher wages is more expensive in terms of lost employment) => wage moderation => lower equilibrium unemployment Norway 2002: High wage growth lead to high interest rate and a strong krone 21

22 In a monetary union, the interest rate is exogenous for each wage setter. o No monetary response deter wage setters, o wage pressure and unemployment are higher than under a countryspecific inflation target In addition: the Walters effect: With a common nominal interest rate, inflation differences are likely to amplify cyclical deviations o The boom in Spain and Ireland led to higher wage and price growth, implying a lower real interest rate which strengthened the boom o Now, a reduction in wages and prices in the crisis-countries will increase the real interest rate, further depressing demand 22

23 b) Effect on the coordination of wage setting Holden (EER, 2005) Theory and evidence suggest that coordination of wage setting leads to considerably lower equilibrium unemployment, without affecting real wages (average finding is 5-6 percentage points lower unemployment!) Why are unions in some countries unable to coordinate on wage restraint? Unions weigh benefits of wage coor. against short run gain by deviating Monetary regime may affect gains from coordination o Strict regime disciplines wage setters, making coordination less benef. o Coordination may only be sustainable under an accommodating regime (or in a monetary union) 23

24 Centralisation of wage setting and monetary regime 16 OECD countries 0.8 Central bank independence C&L US Can UK Ger Fra Jap Swi Aus Den Swe Bel NL A Fin Ita Nor Centralisation of wage setting GWL 24