THE BUSINESS-CYCLE WITH NOMINAL CONTRACTS

In this paper we study the quantitative implications of nominal wage c ontracts for business cycle fluctuations. We address this issue using a model economy based on the neoclassical growth model supplemented by the assumption that cash is needed to purchase goods. We consider a v ariation of the standard recursive competitive equilibrium concept tha t is intended to capture the important features of wage contracting. W e use this equilibrium construct to address three issues. First, we co nsider whether monetary shocks, propagated by nominal contracts, const itute a viable alternative to technology shocks as a source of aggrega te fluctuations. Our results suggest that, while monetary shocks and n ominal rigidities succeed in causing output volatility of the required magnitude, the resulting data have properties that are inconsistent w ith several key features of U.S. data. Second, we consider how the beh avior of the economy varies with contract length. We find that the vol atility induced by both monetary and technology shocks increases sharp ly with contract length. Finally we consider how much rigidity would b e necessary to match the volatility of U.S. output. We find that only a very small amount of rigidity would be necessary to cause output vol atility of the magnitude observed.