back start next


[start] [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18] [19] [20] [21] [22] [23] [24] [25] [26] [27] [28] [29] [30] [31] [32] [33] [34] [35] [36] [37] [38] [39] [40] [41] [42] [43] [44] [45] [46] [47] [48] [49] [50] [51] [52] [53] [54] [55] [56] [57] [58] [59] [60] [61] [62] [63] [64] [65] [66] [67] [68] [69] [70] [71] [72] [73] [74] [75] [76] [77] [78] [79] [80] [81] [82] [83] [84] [85] [86] [87] [88] [89] [90] [91] [92] [93] [94] [95] [96] [97] [ 98 ] [99] [100] [101] [102] [103] [104] [105] [106] [107] [108] [109] [110] [111] [112] [113] [114] [115] [116] [117] [118] [119] [120] [121] [122] [123] [124] [125] [126] [127] [128] [129] [130] [131] [132] [133] [134] [135] [136] [137] [138] [139] [140] [141] [142] [143] [144] [145] [146] [147] [148] [149] [150] [151] [152] [153] [154] [155] [156] [157] [158] [159] [160] [161] [162] [163] [164] [165] [166] [167] [168] [169] [170] [171] [172] [173] [174] [175] [176] [177] [178] [179] [180] [181] [182] [183]


98

A Second Quantitative Example

To see the potential importance of labor-market imperfections, consider the following variation (from Ball and Romer, 1990) on our example of firms

"In addition, ttie possibility of substantial real rigidities in the labor market suggests that small barriers to nominal adjustment may cause nominal disturbances to have substantial real effects through stickiness of nominal wages rather than of nominal prices. If wages display substantial real rigidity, a demand-driven expansion leads only to small increases in optimal real wages. As a result, just as small frictions in nominal price adjustment can lead to substantial nominal price rigidity, small frictions in nominal wage adjustment can lead to substantial nominal wage rigidity.

Barsky, 1995); imperfect information thai makes existing customers more responsive to price increases than prospective new customers are to price decreases, and thus makes the marginal revenue curve steeper (for example, Stiglitz, 1979; Woglom, 1982; and Ball and D. Romer, 1990); caphal-market imperfections that cause liquidity-constrained firms to raise prices during recessions (for example, Greenwald, Stiglitz, and Weiss, 1984, and Chevalier and Scharfstein, 1994); and the fact that higher sales increase the mcentive for firms to deviate from patterns of impUcit collusion by cutting their prices (for example, Rotemberg and Woodford, 1991, 1992).

Although the new Keynesian view of fluctuations does not depend on any specific source of real rigidity and insensitivity of the profit function, it almost surely requires that the cost of labor not fall nearly as dramatically as it would if labor supply is relatively inelastic and workers are on their labor supply curves. If these conditions hold, the Incentive for price adjustment created by the huge swings in the cost of labor almost surely swamp the effects of other factors.

At a general level, real wages might not be highly procyclical for two reasons. First, short-run aggregate labor supply could be relatively elastic (as a result of intertemporal substitution, for example). But as described in Section 4.10, this view of the labor market has had limited empirical success.

Second, imperfections in the labor market-such as those that are the subject of Chapter 10-can cause workers to be off their labor supply curves over at least part of the business cycle. In the efficiency-wage, contracting, and search and matching models presented there, the cost of labor to firms may differ from the opportunity cost of time to workers. The models thus break the link between the elasticity of labor supply and the response of the cost of labor to demand disturbances. Indeed, Chapter 10 presents several models that imply relatively acyclical wages (or relatively acyclical costs of labor to firms) despite inelastic labor supply. If imperfections like these cause real wages to respond little to demand disturbances, they greatly reduce firms incentive to vary their prices in response to these demand shifts.o



incentives to change prices in response to a monetary disturbance. Suppose that for some reason firms pay wages above the market-clearing level, and that the elasticity of the real wage with respect to aggregate output is 13:

= ayp.

(6.87)

Thus, as in Case 3 of Section 5.4, the cyclical behavior of the real wage is determined by a "real-wage function" rather than by the elasticity of labor supply.

With the remainder of the model as before, firm z "s profits are given by (6.37) with real wage equal to AY rather than Y". It follows that

=f(t)"-4f)"(f)"

(compare [6.84]). The profit-maximizing real price is again )/( ) - 1) times the real wage; thus it is [17/(17 - 1)] . It follows that equilibrium output under flexible prices is [(rj - D/tjAI/. Assume that A and 13 are such that labor supply at the flexible-price equilibrium exceeds the amount of labor employed by firms.

Now consider the representative firms incentive to change its price in the face of a decline in aggregate demand, again assuming that other firms do not change their prices. If the firm does not change its price, then P, / = 1, and so (6.88) implies

7rnXED = --A-J ,

(6.89)

If the firm changes its price, it charges a real price of [17/(17 - DJAy. Substituting this expression into (6.88) yields

7J-ADJ =

l-ri

VD-1

/jVf\/3(i-) .P.

-(f)

1,-1

-(f)

(6.90)

= 1

17-1

When prices are flexible, each firm sets its relative price to [77/(77 - l)](W/P). Thus the real wage at the flexible-pnce equilibrium must be (tj D/tj, and so labor supply is [(77-1)/77]. Thus the condition that labor supply exceeds demand at the flexible-price equilibrium is [(77 - D/tj]" > [(r,-l)/77A]"



Other Frictions

The barriers to complete adjustment to nominal disturbances need not be in price and wage adjustment. For example, one recent line of research examines the consequences of the fact that debt contracts are often not indexed; that is, loan agreements and bonds generally specify streams of nominal payments the borrower must make to the lender. Nominal disturbances therefore cause redistributions. A negative nominal shock, for example, increases borrowers real debt burdens. If capital markets are perfect, such redistributions do not have any important real effects; investments continue to be made if the risk-adjusted expected payoffs exceed the costs, regardless of whether the funds for the projects can be supphed by the entrepreneurs or have to be raised in capital markets.

But actual capital markets may not be perfect. Asymmetric information between lenders and borrowers, coupled with risk aversion or limited lia-biUty, generally makes the first-best outcome unattainable. The presence of risk aversion or limited liability means that the borrowers usually do not bear the full cost of very bad outcomes of their investment projects. But if borrowers are partially insured against bad outcomes, they have an incentive to take advantage of the asymmetric information between themselves and lenders by borrowing only if they know their projects are risky (adverse selection) or by taking risks on the projects they undertake (moral hazard). These difficulties cause lenders to charge a premium on their loans. As a result, there is generally less investment, and less efficient investment, when it is financed externally than when it is funded by the entrepreneurs own funds.

If jS, the parameter that governs the cyclical behavior of the real wage, is small, the effect of this change in the model on the incentive for price adjustment is dramatic. Suppose, for example, that p =0.1, that rj = 5 as before, and that A = 0.806 (so that the flexible-price level of Y is 0.928, or about 95% of its level with v = 0.1 and a clearing labor market). Substituting these parameter values into (6.89) and (6.90) implies that if the money stock falls by 3% and firms do not adjust their prices, the representative firms gain from changing its price is approximately 0.0000168, or about 0.0018% of the revenue it gets at the flexible-price equilibrium. Even if M falls by 5% and jS =0.25 (and A is changed to 0.815, so that the flexible-price level of Y continues to be 0.928), the incentive for price adjustment is only 0.03% of the firms flexible-price revenue. Thus ifthe labor market is such that an equation like (6.87) with a relatively small value of /3 correctly describes the cyclical behavior of labor costs, and if the remaining features of the model are not greatly misleading, small barriers to nominal price adjustment can give rise to substantial nominal rigidity.



[start] [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18] [19] [20] [21] [22] [23] [24] [25] [26] [27] [28] [29] [30] [31] [32] [33] [34] [35] [36] [37] [38] [39] [40] [41] [42] [43] [44] [45] [46] [47] [48] [49] [50] [51] [52] [53] [54] [55] [56] [57] [58] [59] [60] [61] [62] [63] [64] [65] [66] [67] [68] [69] [70] [71] [72] [73] [74] [75] [76] [77] [78] [79] [80] [81] [82] [83] [84] [85] [86] [87] [88] [89] [90] [91] [92] [93] [94] [95] [96] [97] [ 98 ] [99] [100] [101] [102] [103] [104] [105] [106] [107] [108] [109] [110] [111] [112] [113] [114] [115] [116] [117] [118] [119] [120] [121] [122] [123] [124] [125] [126] [127] [128] [129] [130] [131] [132] [133] [134] [135] [136] [137] [138] [139] [140] [141] [142] [143] [144] [145] [146] [147] [148] [149] [150] [151] [152] [153] [154] [155] [156] [157] [158] [159] [160] [161] [162] [163] [164] [165] [166] [167] [168] [169] [170] [171] [172] [173] [174] [175] [176] [177] [178] [179] [180] [181] [182] [183]