Unemployment Fluctuations and Stabilization Policies

Unemployment Fluctuations and Stabilization Policies: A New Keynesian Perspective

Jordi Galí
Copyright Date: 2011
Published by: MIT Press
Pages: 120
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  • Book Info
    Unemployment Fluctuations and Stabilization Policies
    Book Description:

    The past fifteen years have witnessed the rise of the New Keynesian model as a framework of reference for the analysis of fluctuations and stabilization policies. That framework, which combines the rigor and internal consistency of dynamic general equilibrium models with such typically Keynesian assumptions as monopolistic competition and nominal rigidities, makes possible a meaningful, welfare-based analysis of the effects of monetary policy rules. But the conspicuous absence of unemployment from the standard New Keynesian model has given rise to both criticism and attempts to rectify this anomaly. In this book, Jordi Galí, one of the major contributors to the New Keynesian literature, offers a new approach to introducing unemployment into that framework. Galí's approach involves a reinterpretation of the labor market in the standard New Keynesian model with staggered wage setting (rather than a modification or extension of the model, as has been proposed by others). The resulting framework preserves the convenience of the representative household paradigm and allows one to determine the equilibrium levels of employment, the labor force, and hence the unemployment rate conditional on the monetary policy in place. Galí develops the basic model, embedding it in a standard New Keynesian framework with staggered price and wage setting; revisits the relationship between economic fluctuations and efficiency through the lens of the new model, developing a measure of the output gap; and analyzes the relation between unemployment and the design of monetary policy.

    eISBN: 978-0-262-29879-7
    Subjects: Economics

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Series Foreword
    (pp. ix-x)
    Karl Gunnar Persson

    The Zeuthen Lectures offer a forum for leading scholars to develop and synthesize novel results in theoretical and applied economics. The Zeuthen Lectures are organized by the Institute of Economics, University of Copenhagen. The aim is to present advances in knowledge in a form accessible to a wide audience of economists and advanced students of economics. The topics range from abstract theorizing to economic history. Regardless of the choice of topic, the emphasis in the lecture series is on originality and relevance.

    The lecture series is named after Frederik Zeuthen, a former professor at the Institute of Economics....

  4. Preface
    (pp. xi-xii)
  5. Introduction
    (pp. 1-6)

    For the past fifteen years the New Keynesian model has served as a frame of reference for analyses of fluctuations and stabilization policies.¹ That framework has allowed the rigor and internal consistency of dynamic general equilibrium models to be combined with typically Keynesian assumptions, like monopolistic competition and nominal rigidities, thus setting the stage for a meaningful, welfare-based analysis of the effects of alternative monetary policy rules. Indeed many central banks and policy institutions have adopted medium-scale versions of that model for simulation and forecasting purposes.²

    But success breeds criticism, and the New Keynesian model has been no exception. Among...

  6. 1 A Simple Model of Unemployment and Inflation Dynamics
    (pp. 7-36)

    The New Keynesian model with staggered wage and price setting of Erceg, Henderson, and Levin (2000; henceforth, EHL) constitutes the core of the dynamic stochastic general equilibrium (DSGE) frameworks that have become popular in recent years, and that have been adopted by many central banks and policy institutions as an analytical tool. While the EHL model lacks many of the bells and whistles that have been incorporated in the estimated medium-scale models, it remains useful in elucidating the implications of nominal rigidities for the design of monetary policy.¹

    The variant presented here, based on Gaí (2011a), treats labor as being...

  7. 2 Unemployment, the Output Gap, and the Welfare Costs of Economic Fluctuations
    (pp. 37-60)

    The instability associated with business cycles has traditionally been regarded as one of the unpleasant sides of capitalism, and a price society has to pay in order to reap the longer term benefits of free enterprise and market-driven innovation. At least since Keynes (1936), recessions have been viewed as periods in which the economy operates below the efficient level of activity and resource utilization. Expansions, in contrast, bring the economy close to the efficient level. That interpretation of the ups-and-downs in business activity has underpinned the adoption of stabilization policies aimed at dampening (if not fully eliminating) economic downturns.


  8. 3 Unemployment and Monetary Policy Design in the New Keynesian Model
    (pp. 61-82)

    In the present chapter I shift the focus to normative issues. In particular, I analyze the desirability of alternative monetary policy rules in the context of the New Keynesian model developed in chapter 1. To be clear, I am not the first to do so. Erceg, Henderson, and Levin (2000) have already derived the optimal monetary policy in a nearly identical model, and studied the welfare consequences of alternative (suboptimal) policies. Similar analyses can also be found in Woodford (2003) and Galí (2008), among others. That earlier work, however, did not make any reference to unemployment, since the latter variable...

  9. 4 Concluding Remarks and Directions for Future Research
    (pp. 83-88)

    In this book I have proposed an alternative approach for introducing unemployment in the New Keynesian framework. The proposed approach involves areinterpretationof the labor market block of that model, as originally developed by Erceg, Henderson, and Levin (2000), as opposed to a significant modification of the latter.

    Through a number of exercises I have shown how that approach can be used in practice to address many questions of interest. Let me next summarize the main findings in the form of bullet points.

    A calibrated version of the standard New Keynesian model has been shown to be capable of...

  10. Appendix A
    (pp. 89-90)
  11. Appendix B
    (pp. 91-92)
  12. Appendix C
    (pp. 93-94)
  13. Appendix D
    (pp. 95-96)
  14. References
    (pp. 97-102)
  15. Index
    (pp. 103-106)