Home About Latest Browse RSS Advanced Search

Federal Reserve Bank of Boston
Working Papers
Real wage rigidities and the New Keynesian model
Olivier Jean Blanchard
Jordi Galí
Abstract

Most central banks perceive a trade-off between stabilizing inflation and stabilizing the gap between output and desired output. However, the standard new Keynesian framework implies no such trade-off. In that framework, stabilizing inflation is equivalent to stabilizing the welfare-relevant output gap. In this paper, we argue that this property of the new Keynesian framework, which we call the divine coincidence, is due to a special feature of the model: the absence of nontrivial real imperfections. ; We focus on one such real imperfection, namely, real wage rigidities. When the baseline new Keynesian model is extended to allow for real wage rigidities, the divine coincidence disappears, and central banks indeed face a trade-off between stabilizing inflation and stabilizing the welfare-relevant output gap. We show that not only does the extended model have more realistic normative implications, but it also has appealing positive properties. In particular, it provides a natural interpretation for the dynamic inflation-unemployment relation found in the data.


Download Full text
Download Full text
Cite this item
Olivier Jean Blanchard & Jordi Galí, Real wage rigidities and the New Keynesian model, Federal Reserve Bank of Boston, Working Papers 05-14, 2005.
More from this series
JEL Classification:
Subject headings:
Keywords: Keynesian economics ; Monetary policy ; Inflation (Finance)
For corrections, contact Catherine Spozio ()
Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

Privacy Legal