Working Paper: NBER ID: w10889
Authors: Matthew B. Canzoneri; Robert E. Cumby; Behzad T. Diba
Abstract: We calculate the welfare cost of nominal inertia in a New Neoclassical Synthesis model with wage and price stickiness, capital formation, and empirically estimated rules for government spending and the cental bank's interest rate policy. We calibrate our model to U.S. data, and we show that it captures many aspects of the U.S. business cycle. Moreover, our model is capable of generating the kind of volatility that has been observed in the efficiency gaps emphasized by Erceg, Henderson and Levin (2000) and Gali, Gertler and Lopez-Salido (2002). We also highlight some of the empirical shortcomings of the model; in particular, demand side shocks appear to be either missing or improperly modeled. We calculate the cost of nominal inertia under two specifications of monetary policy. The bottom line is that, under our preferred specification of monetary policy, the model implies a conservative estimate of the cost that is twenty to sixty times larger than Lucas's (2003) estimate: the "average" household in our model would be willing to give up one to three percent of consumption each period to be free of the effects of wage and price stickiness. Wage inertia appears to be the major source of these welfare costs.
Keywords: No keywords provided
JEL Codes: E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nominal rigidity (D10) | welfare costs (I30) |
| wage and price stickiness (E31) | household welfare (I38) |
| monetary policy specifications (E52) | welfare costs of nominal inertia (D69) |
| bad policy rule (D78) | welfare costs of nominal inertia (D69) |
| good policy rule (E61) | welfare costs of nominal inertia (D69) |
| observed volatility in marginal rate of substitution (D11) | welfare costs (I30) |
| observed volatility in marginal product of labor gap (J69) | welfare costs (I30) |