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MIU model with rigid wages

F. Alvarez, A. Budai, D. Matveev, P. Wu

IDEA-UAB

May, 2010

F. Alvarez, A. Budai, D. Matveev, P. Wu (IDEA-UAB)


MIU model with rigid wages May, 2010 1/7
Description of the model
Assumptions

Intro
Following chapter 5 from the Walsh book we use linear approximation of
the Sidrauski MIU model.
Capital stock is treated as fixed, investment is zero
CES utility function separable in consumption and money holdings

act1−b + (1 − a)mt1−b (1 − nt )1−η


u(ct , mt , 1 − nt ) = + +Ψ
1−Φ 1−Φ 1−η
Cobb-Douglas production function

yt ≡ f (zt , nt ) = e et nt1−α

F. Alvarez, A. Budai, D. Matveev, P. Wu (IDEA-UAB)


MIU model with rigid wages May, 2010 2/7
Description of the model
Equilibrium

The equations characterizing equilibrium

yt = (1 − α)nt + et (production function) (1)


yt = ct (resource constraint) (2)
yt − nt = ωt − pt (labor demand) (3)
ΦEt (ct+1 − ct ) = rt (FOC wrt consumption) (4)
nss
 
η nt + Φct = ωt − pt (FOC wrt leisure) (5)
1 − nss
 
1
mt − pt = ct − it (FOC wrt money) (6)
b
it = rt + Et pt+1 − pt (Fisher equation) (7)
m t = st (Money supply) (8)

F. Alvarez, A. Budai, D. Matveev, P. Wu (IDEA-UAB)


MIU model with rigid wages May, 2010 3/7
Description of the model
Introduce wage rigidity

Wage indexation definition


Wage contract with indexation consists of:
Wage base
Indexation formula
Frequency of indexation

Define wage contract


As nominal wage base we take

ωtb = Et−1 ωt∗ + Et−1 pt ,

where ωt∗ is flex-price equilibrium real wage.


Indexation is made each period by following formula

wtc = ωtb + δ(pt − Et−1 pt ), 06δ61 (9)


F. Alvarez, A. Budai, D. Matveev, P. Wu (IDEA-UAB)
MIU model with rigid wages May, 2010 4/7
Effects of rigid wages

Actual employment
From labor demand equation (3) and indexation formula (9) we derive
actual employment that firm chooses when period comes
1−δ 1
nt = Et−1 nt∗ + (pt − Et−1 pt ) + εt (10)
α α
We have that employment deviates from the expected flex-price
equilibrium level nt∗ due to the movement in prices and productivity shock.

F. Alvarez, A. Budai, D. Matveev, P. Wu (IDEA-UAB)


MIU model with rigid wages May, 2010 5/7
Effects of rigid wages
Aggregate supply and demand
Substitute derived above (10) into production function (1) and assume
that production shocks are serially uncorrelated to obtain aggregate supply

yt = a(1 − δ)(pt − Et−1 pt ) + (1 + a)εt (11)

Aggregate demand is defined by yt = mt − pt

Equilibrium output
Note that aggregate demand and money supply (8) imply
pt − Et−1 pt = st − yt . Then equilibrium output is
1−α 1
yt = st + εt
1 − δ(1 + α) 1 − δ(1 + α)

Thus we can see that increase in δ imply increasing influence of production


and money shocks on output fluctuations.
F. Alvarez, A. Budai, D. Matveev, P. Wu (IDEA-UAB)
MIU model with rigid wages May, 2010 6/7
Optimal Indexation Parameter

Objective function
It is plausible to assume that workers prefer to minimize deviations
between actual employment and employment under flexible wages, thus we
define their objective as
 2  2
(1 − δ)(α − δ(1 + α)) δ
Vart−1 [nt − Et−1 nt∗ ] = σs2 + σε2
α(1 − δ(1 + α)) 1 − δ(1 + α)

Analytical results
Unfortunately given function doesn’t provide good analytical solution
unless we assume absence of one of the shocks.
No money shocks (Vart−1 (st ) = 0), then δ = 0 is optimal
No production shocks (Vart−1 (εt ) = 0), then δ = 1 is optimal

F. Alvarez, A. Budai, D. Matveev, P. Wu (IDEA-UAB)


MIU model with rigid wages May, 2010 7/7

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