Working Paper: CEPR ID: DP14888
Authors: Roberto M. Billi; Jordi Gal
Abstract: We analyze the welfare impact of greater wage flexibility in the presence of an occasionally binding zero lower bound (ZLB) constraint on the nominal interest rate. We show that the ZLB constraint generally amplifies the adverse effects of greater wage flexibility on welfare when the central bank follows a conventional Taylor rule. When demand shocks are the driving force, the ZLB implies that an increase in wage flexibility reduces welfare even under the optimal monetary policy with commitment.
Keywords: labor-market flexibility; nominal rigidities; optimal monetary policy with commitment; Taylor rule; ZLB constraint
JEL Codes: E24; E32; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ZLB constraint (E62) | adverse effects of greater wage flexibility on welfare (F66) |
| increase in wage flexibility (J38) | reduce welfare (I38) |
| ZLB constraint (E62) | procyclical response of real interest rate when wage subsidies are implemented during a recession (E43) |
| increased wage flexibility (J39) | welfare-reducing (D69) |
| ZLB constraint (E62) | larger welfare losses from simultaneous reduction in both price and wage rigidities (D69) |
| ZLB constraint (E62) | raises range of nominal rigidities for which welfare losses decrease with degree of nominal rigidities (D69) |