Optimal monetary policy with staggered wage and price contracts

We formulate an optimizing-agent model in which both labor and product mark ets exhibit monopolistic competition and staggered nominal contracts. The u nconditional expectation of average household utility can be expressed in t erms of the unconditional variances of the output Sap, price inflation, and wage inflation. Monetary policy cannot achieve the Pareto-optimal equilibr ium that would occur under completely flexible wages and prices: that is, t he model exhibits a tradeoff in stabilizing the output gap, price inflation , and wage inflation. We characterize the optimal policy rule for reasonabl e calibrations of the model. We also find that strict price inflation targe ting generates relatively large welfare losses, whereas several other simpl e policy rules perform nearly as well as the optimal rule. (C) 2000 Publish ed by Elsevier Science B.V. All rights reserved. JEL classification: E31; E 32; E52.