Martin Wolf (Universität Wien) – Optimal Prudential Policy in Economies with Downward Wage Rigidity

Abstract:
This paper studies optimal policy in economies with downward nominal wage rigidity when only prudential instruments are available. The optimal prudential policy  intervenes in the labor market while all other markets may clear competitively. In contrast to fiscal devaluation where labor is subsidized in recessions, the prudential policy taxes  labor in expansions as this curtails unemployment in recessions. However, the economy produces below potential in expansions. We analyse this trade-off theoretically and quantitatively by applying the model to Greece. We find that prudential intervention before 2008 would have significantly reduced Greek unemployment after 2008. The welfare cost of downward wage rigidity is reduced by about half. Our results hold in a Walrasia  labo  market, and in a labor market with wage-setting firms.

Friday, November 9, 2018, 11:00 a.m.

Oesterreichische Nationalbank
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