DP14888 Gains from Wage Flexibility and the Zero Lower Bound

Author(s): Roberto M Billi, Jordi Galí
Publication Date: June 2020
Keyword(s): labor-market flexibility, nominal rigidities, optimal monetary policy with commitment, Taylor rule, ZLB constraint
JEL(s): E24, E32, E52
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14888

We analyze the welfare impact of greater wage flexibility in the presence of an occasionally binding zero lower bound (ZLB) constraint on the nominal interest rate. We show that the ZLB constraint generally amplifies the adverse effects of greater wage flexibility on welfare when the central bank follows a conventional Taylor rule. When demand shocks are the driving force, the ZLB implies that an increase in wage flexibility reduces welfare even under the optimal monetary policy with commitment.