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IDEA-UAB
May, 2010
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
yt ≡ f (zt , nt ) = e et nt1−α
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.
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)
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