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How Monetary Policy can have Permanent Real Effects with Only Temporary Nominal Rigidity

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  • Ian M. McDonald
  • Hugh Scully

Abstract

A macroeconomic model is developed in which the psychological concept of loss aversion is incorporated into workers’ preferences. The impact of monetary policy in the presence of loss aversion depends on the specification of the reference wage. The plausible specification that a worker’s reference wage is the real wage she was paid in the previous period is considered in detail. Specifying the reference wage in this way, we show that an unanticipated change in monetary policy has a permanent, real effect when short term labour contracts are written in nominal wages.

Suggested Citation

  • Ian M. McDonald & Hugh Scully, 2001. "How Monetary Policy can have Permanent Real Effects with Only Temporary Nominal Rigidity," Scottish Journal of Political Economy, Scottish Economic Society, vol. 48(5), pages 532-546, November.
    • Handle: RePEc:bla:scotjp:v:48:y:2001:i:5:p:532-546
    DOI: 10.1111/1467-9485.00213
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    Cited by:

    1. Ahrens, Steffen & Pirschel, Inske & Snower, Dennis J., 2017. "A theory of price adjustment under loss aversion," Journal of Economic Behavior & Organization, Elsevier, vol. 134(C), pages 78-95.

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