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Optimal Prudential Policy in Economies with Downward Wage Rigidity

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Abstract

This paper studies optimal policy in economies with downward nominal wage rigidity when only prudential instruments are available. The optimal policy reduces labor demand in expansions as this curtails unemployment in recessions. The cost of the intervention is that in expansions, the economy produces below potential. We characterize this trade-o theoretically and quantitatively by applying our model to Greece, 1999-2016. We and that the optimal prudential policy would have significantly reduced Greek unemployment after the downturn in 2008. Furthermore, we and large welfare gains of the optimal prudential policy, removing about one fourth of the total welfare cost of downward wage rigidity.

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  • Martin Wolf, 2018. "Optimal Prudential Policy in Economies with Downward Wage Rigidity," Vienna Economics Papers vie1804, University of Vienna, Department of Economics.
    • Handle: RePEc:vie:viennp:vie1804
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    More about this item

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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