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

44 Pages Posted: 11 Jun 2008

See all articles by Olivier J. Blanchard

Olivier J. Blanchard

National Bureau of Economic Research (NBER); Peterson Institute for International Economics

Jordi Galí

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: March 2008

Abstract

We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation trade-off and for the conduct of monetary policy.

We proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We show the role of labour market frictions and real wage rigidities in determining the effects of productivity shocks on unemployment.

We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of labour market frictions and real wage rigidities. We show the nature of the trade-off between inflation and unemployment stabilization, and its dependence on labour market characteristics. We draw the implications for optimal monetary policy.

Keywords: Labour market frictions, New Keynesian Model, real wage rigidities, search model, sticky prices, unemployment

JEL Classification: E32, E50

Suggested Citation

Blanchard, Olivier J. and Gali, Jordi, Labour Markets and Monetary Policy: A New Keynesian Model with Unemployment (March 2008). CEPR Discussion Paper No. DP6765, Available at SSRN: https://ssrn.com/abstract=1141670

Olivier J. Blanchard (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Peterson Institute for International Economics ( email )

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Washington, DC 20036
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Jordi Gali

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2754 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~gali

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Cambridge, MA 02142
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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