DP6726 The Role of Contracting Schemes for Assessing the Welfare Costs of Nominal Rigidities

Author(s): Matthias Paustian , Jürgen von Hagen

Publication Date: February 2008

Keyword(s): Calvo Pricing , Monetary Policy Rules , Nominal Rigidities , Sticky Information , Taylor Contracts

JEL(s): E32 , E52

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6726.asp.asp

Due to the lack of pertinent evidence, there is currently no agreement on how to introduce nominal rigidities into monetary macroeconomic models. We examine the role of alternative assumptions about the wage and price setting mechanisms for the assessment of the welfare costs of nominal rigidities and the performance of alternative monetary policy rules in an otherwise standard New Keynesian general equilibrium model. We find that the choice of a particular price and wage setting scheme matters quantitatively for the welfare costs of nominal rigidities. However, qualitative statements such as the welfare ranking of alternative monetary policy rules are robust to changes in contracting schemes. The difference between sticky nominal contracts and sticky information matters more than the difference in the age distribution of prices wages and information implied by alternative price and wage setting schemes.