Macroeconomics

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Macroeconomics

• Lecture 3
• The sticky wage model and the business cycle.

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Outline

• Nominal and real rigidities
• The sticky wage model
• The sticky real wage model

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Keynesian and New Keynesian theories of the cycle
Inflexible wages and prices prevent the economy
from adjusting immediately to shocks
Short-run fluctuations in real GDP around the
long-run equilibrium level of output
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Two types of rigidities
Non-market clearing in the short-run but market
clearing in the long-run
Nominal rigidities
Short-run fluctuations around the natural level
of output (full employment)

Non-market clearing in the short-run and in the
long-run
Real rigidities
Short-run fluctuations around the structural
level of output (below full employment)
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Main assumptions of the stickywage model
A1 Long-term nominal wage contracts (nominal
rigidity).
A2 Right-to-manage
A3 Real wage target consistent with full
employment (no real rigidity)
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The sticky wage model
Goal Full employment
Nominal rigidity
Nominal wage contracts cover extended periods
of time
Contracts based on price expectations at the
contract day

Due to events that was unanticipated at
the contract day, expectations will be wrong
Short-run fluctuations in real GDP and employment
around full employment
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Perfect competi- tion
Rationalexpecta-tion
Nominal wage contract
Firms
Union
Real wage target
Workers
Right-to- manage
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The long-run equilibrium
Unions expectations are fulfilled and reflected
in the wage contract, i.e., the real wage target
has been achieved.
Real wage target consistent with full employment
Long-run full employment
The natural level of output
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Long-run equilibrium PPe
W
Wc
L
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Short-run equilibrium
Because of unanticipated events that occur after
the contract has been signed, the rational price
expectation is not fulfilled.
Real wage target is not achieved
Employment below or above full employment
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Deriving the short-run AS in the sticky wage model
PegtPC
LAS
P
AS(WC)
PB
C
B
A
PePA
A
PC
C
B
L
Y
LC
YC
LB
YB
PeltPC
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Why is the AS upwards sloping?
Union overestimated price level
WC set too high
WC/P above target
Ld reduced
Unanticipated reduction in the price
Y decreases
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The aggregate supply curve II
Natural level of output
Change in the price level that was unanticipated
at the contract day

• Technology
• Factor availability
• Tax and social security policy

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Real wage rigidities
Real wage target is inconsistent with full
employment.
The economy will not move to a situation of full
employment in the long-run.
The labor market is not clearing in the long-run.
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Main assumptions of the stickyreal wage model
A1 Long-term nominal wage contracts (nominal
rigidity).
A2 Right-to-manage
A3 Real wage target above the full
employment real wage (real rigidity)
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The long-run equilibrium
Unions expectations are fulfilled and reflected
in the wage contract, i.e., the real wage target
has been achieved.
Real wage target above full employment level
Employment below full employment
The structural level of output
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Wait unemployed
Search u
C
B
The natural level of employment
Structural level of u
A
Natural level of u
The structural level of employment
L
LF
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P
A
B
Y
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The aggregate supply curve III
Structural level of output
Change in the price level that was unanticipated
at the contract day

• Technology
• Factor availability
• Tax and social security policy
• Market imperfections

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Sources of real wage rigidity
Outsiders
Insiders
Union power
Motivation when monitoring is difficult
Efficiency wages
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Comparing the two models
Misperception models
Sticky wage models
Market clearing
Nominal or real rigidities
Misperceptions about shocks
Long-term contracts
Expectations
Staggered contracts
Full employment
Full employment/ not full employment
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What is next?

• Analyzing the business cycle in the sticky wage
  model.