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The role of contracting schemes for the welfare costs of nominal rigidities

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  • Matthias Paustian

Abstract

This paper asks the following two questions: First, can a model with nominal rigidities in wage and price setting account for the average welfare costs of business cycle fluctuations identified in Gali, Gertler, and Lopez- Salido (2003)? Second, what is the role of contracting schemes for the welfare costs of business cycle fluctuations? We compute a quadratic approximation to agents expected lifetime utility and evaluate welfare for different modeling schemes of nominal rigidities that all have the same average duration of contracts. Calvo (1983) wage and price contracts can deliver sizeable welfare costs, but other contracts of the same average stickiness cannot. Calvo (1983) contracts can imply welfare costs that are up to 4 times higher than those implied by overlapping contracts in the spirit of Taylor (1980) or Wolman (1999). Furthermore, the sticky information framework of Mankiw and Reis (2002) may generate welfare costs that are even smaller. This paper calls for more research into the origins of wage and price stickiness

Suggested Citation

  • Matthias Paustian, 2005. "The role of contracting schemes for the welfare costs of nominal rigidities," Computing in Economics and Finance 2005 196, Society for Computational Economics.
    • Handle: RePEc:sce:scecf5:196
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    Cited by:

    1. Woodford, Michael, 2009. "Information-constrained state-dependent pricing," Journal of Monetary Economics, Elsevier, vol. 56(S), pages 100-124.
    2. Avouyi-Dovi, Sanvi & Sahuc, Jean-Guillaume, 2011. "On the welfare costs of misspecified monetary policy objectives," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 151-161, June.
    3. Kara, Engin, 2010. "Optimal monetary policy in the generalized Taylor economy," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 2023-2037, October.
    4. David Aikman & Matthias Paustian, 2006. "Bank capital, asset prices and monetary policy," Bank of England working papers 305, Bank of England.
    5. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2007. "The Cost of Nominal Rigidity in NNS Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1563-1586, October.

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    More about this item

    Keywords

    welfare; Calvo; Taylor; sticky information; costs of nominal rigidities;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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