Effect of sticky Wages on the Behavior of Economic Agents with Heterogeneous Expectations

Abstract

The aim of the work is to analyze the changes and behavioral features of economic agents when wage rigidity is incorporated into the new Keynesian model in comparison with the model with flexible wages and rigid prices under cognitive constraints of agents. The relevance of the work lies in the fact that the model under study is able to describe the typical features of the movement of a real business cycle. The working hypothesis is an assumption that the forecasting of the output gap, inflation of prices and wages occurs with the help of fundamentalist and extrapolation rules. The first rule is based on the prediction of the studied variables based on their stationary values. The second rule is based on the extrapolation of the latest available data for the variables under study. The weight shares of agents applying these heuristic rules change endogenously, which is the source of endogenous waves of optimism and pessimism, and the scientific novelty of the analysis of models with an imperfect labor market. An analysis of the impulse responses of an interest rate shock and a technological shock suggests that a more flexible economy (an economy with flexible wages and rigid prices) is less prone to an abrupt economic cycle caused by waves of optimism and pessimism than a more rigid economy. These shocks cause ripple effects in the economy, meaning that a tight economy will be more prone to booms and busts driven by alternating optimism and pessimism than an agile economy. It is concluded that the difference between the degree of optimism and pessimism in the base model, as well as in the model with rigid wages and prices, is the full trust of agents in the Central Bank in targeting wage inflation in the absence of stabilization of this inflation by the bank. The practical significance of the work lies in the fact that the results obtained may be useful in stabilizing the considered variables under the monetary policy of the Central Bank.