Working Paper: CEPR ID: DP18542
Authors: Florin Bilbiie; Mathias Trabandt
Abstract: We show an equivalence result in the standard representative agent New Keynesian model after demand, wage markup and correlated price markup and TFP shocks: assuming sticky prices and flexible wages yields identical allocations for GDP, consumption, labor, inflation and interest rates to the opposite case---flexible prices and sticky wages. This equivalence result arises if the price and wage Phillips curves' slopes are identical and generalizes to any pair of price and wage Phillips curve slopes such that their sum and product are identical. Nevertheless, the cyclical implications for profits and wages are substantially different. We discuss how the equivalence breaks when these factor-distributional implications matter for aggregate allocations, e.g. in New Keynesian models with heterogeneous agents, endogenous firm entry, and non-constant returns to scale in production.
Keywords: sticky prices; sticky wages; New Keynesian model; inflation; output; interest rate; observational equivalence
JEL Codes: E1; E3; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sticky prices and flexible wages (J31) | identical allocations for GDP, consumption, labor, inflation, and interest rates (E20) |
| flexible prices and sticky wages (E31) | identical allocations for GDP, consumption, labor, inflation, and interest rates (E20) |
| slopes of price and wage Phillips curves are identical (E31) | identical allocations for GDP, consumption, labor, inflation, and interest rates (E20) |
| arbitrary combination of price and wage Phillips curve slopes (sum and product constant) (E31) | identical allocations for GDP, consumption, labor, inflation, and interest rates (E20) |
| sticky prices and flexible wages (J31) | cyclical implications for profits and wages differ (E25) |
| flexible prices and sticky wages (E31) | cyclical implications for profits and wages differ (E25) |