Sticky Nominal Wages and the Optimal Employment Rule

Abstract

conventional monetary theory implies increases in the money supply will increase aggregate demand, and, consequently, raise the general price level and real output. One approach to the division of increased aggregate demand between prices and real output is the Natural Rate-Rational Expectations (NRRE) hypothesis. Papersby Robert Lucas (1972), Thomas Sargent (1973), and Thomas Sargent and Neil Wallace (1975), show that this hypothesis implies a very pessimistic view of the ability of the monetary authority to dampen cyclical fluctuations in real output. Under the NRRE hypothesis real output is independent of the systematic compenect of monetary policy. Some economists are critical of the auction market basis of NRRE hypothesis. For instance, Stanley Fischer (1977a) hypothesizes a macroeconomic model where sitcky nominal wage contracts prevent workers and entrepreneurs from offetting the effects of systematic policy on real wages. These changes in the real wage are assumed to induce changes in employment. Thus, in Fischer's model sticky nominal wage contracts imply a role for systematic monetary policy and also provide a rationale for the positive correlation between prices and real output.