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Bilbiie, F. O., Trabandt, M.

Sticky Prices or Sticky Wages? An Equivalence Result

JIWP Number: 2318

Abstract: We show an equivalence result in the standard representative agent New Keynesian model after demand shocks: assuming sticky prices and flexible wages yields identical allocations for GDP, consumption, labor, inflation and interest rates to the opposite case flexible prices and sticky wages. This equivalence result arises if the price and wage Phillips curves-slopes are identical and generalizes to any pair of price and wage Phillips curve slopes such that their sum and product are identical. Nevertheless, the cyclical implications for profits and wages are substantially different. We discuss how the equivalence breaks when these factor-distributional implications matter for aggregate allocations, e.g. in New Keynesian models with heterogeneous agents, endogenous firm entry, and non-constant returns to scale in production.

Keywords: inflation, Interest Rate, New Keynesian Model, Observational Equivalence, Output, Sticky Prices, Sticky Wages

JEL Codes: E10 E30 E50

Author links: Florin Bilbiie  

PDF: jiwp2318.pdf

Open Access Link: 10.17863/CAM.104880

Theme: transmission