Economist's View: Divine Coincidence is Unlikely
Mark Thoma tells us to go read Blanchard and Gali on nominal vs. real "rigidities" and the business cycle:
Economist's View: Divine Coincidence is Unlikely: The... the general question is straightforward. Do policymakers face an inflation-output tradeoff when conducting monetary policy?...
"Real Wage Rigidities and the New Keynesian Model," Olivier Blanchard and Jordi Gali, September 9, 2005: 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... is due to a special feature of the model, the absence of non-trivial real imperfections. We focus on... real wage rigidities. When the baseline new Keynesian model is extended to allow for real wage rigidities... 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.
