Working Paper: NBER ID: w18092
Authors: Stephanie Schmitt-Grohé; Martín Uribe
Abstract: The combination of a fixed exchange rate and downward nominal wage rigidity creates a real rigidity. In turn, this real rigidity makes the economy prone to involuntary unemployment during external crises. This paper presents a graphical analysis of alternative policy strategies aimed at mitigating this source of inefficiency. First- and second-best monetary and fiscal solutions are analyzed. Second-best solutions are found to be prudential, whereas first-best solutions are not.
Keywords: currency pegs; fixed exchange rates; nominal wage rigidity; involuntary unemployment; policy interventions
JEL Codes: F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fixed exchange rates + nominal wage rigidity (F31) | involuntary unemployment (J64) |
| devaluation of domestic currency (F31) | full employment (J68) |
| labor subsidies (J89) | employment levels (J23) |
| capital controls (F38) | labor market outcomes (J48) |
| external shocks (like interest rate increases) (E49) | involuntary unemployment (J64) |