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Inequality, Nominal Rigidities, and Aggregate Demand

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  • Sebastian Diz
  • Mario Giarda
  • Damián Romero

Abstract

This paper studies wage and price flexibility as a means of absorbing adverse shocks. We focus on economies with unequal access to financial markets and where the monetary authority is constrained by the zero lower bound. We show that the economy becomes more volatile in this setting when wages are more flexible. As our model assumes financial frictions, wage flexibility translates into output volatility via a redistribution channel, which operates through aggregate demand. We find that this volatility depends on the relative wage and price rigidity. Additionally, we show that the redistribution channel gains prominence when the central bank is at the zero lower bound. We conclude that in these kinds of economies, the usual recommendation of making labor markets more flexible to restore high output levels, is mistaken.

Suggested Citation

  • Sebastian Diz & Mario Giarda & Damián Romero, 2021. "Inequality, Nominal Rigidities, and Aggregate Demand," Working Papers Central Bank of Chile 929, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:929
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    Cited by:

    1. Bilbiie, Florin & Trabandt, Mathias, 2023. "Sticky Prices or Sticky Wages? An Equivalence Result," CEPR Discussion Papers 18542, C.E.P.R. Discussion Papers.
    2. Makram El-Shagi & Steven Yamarik, 2024. "The Effect of Monetary Policy Shocks on Income Inequality across US states," CFDS Discussion Paper Series 2024/4, Center for Financial Development and Stability at Henan University, Kaifeng, Henan, China.

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    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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