Summary
In this paper we study the quantitative implications of nominal wage contracts 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 variation of the standard recursive competitive equilibrium concept that is intended to capture the important features of wage contracting. We use this equilibrium construct to address three issues. First, we consider whether monetary shocks, propagated by nominal contracts, constitute a viable alternative to technology shocks as a source of aggregate fluctuations. Our results suggest that, while monetary shocks and nominal rigidities succeed in causing output volatility of the required magnitude, the resulting data have properties that are inconsistent with several key features of U.S. data. Second, we consider how the behavior of the economy varies with contract length. We find that the volatility induced by both monetary and technology shocks increases sharply with contract length. Finally we consider how much rigidity would be 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 volatility of the magnitude observed.
Similar content being viewed by others
References
Aiyagari, R. S.: On the contribution of technology shocks to business cycles Quart. Rev. (1994)
Akerlof, G., Yellen, J.: A near-rational model of the business cycle with wage and price inertia. Quart. J. Econ.100, 823–38 (1985)
Alogoskoufis, G. S.: On intertemporal substitution and aggregate labor supply. J. Polit. Econ.95, 938–960 (1987)
Barro, R.: Unanticipated money growth output and the price level in the United States. J. Pol. Econ.86, 549–580 (1978)
Barro, R. J., Grossman, H. I.: A general disequilibrium model of income and employment. Amer. Econ. Rev.61, 82–93 (1971)
Barro, R. J., Grossman, H. I.: Money, employment and inflation. Cambridge: Cambridge University Press, 1976
Bils, M.: Indexation and contract length in unionized U. S. manufacturing. In Eberts, R. W., Groshen, E. L. (eds) Structural change in U.S. labor markets: Causes and consequences. Armonk and London: Sharpe 1991
Bils, M., Cho, J. O.: Cyclical factor utilization. J. Monet. Econ.
Blinder, A. S., Mankiw, N. G.: Aggregation and stabilization policy in a multi-contract economy. J. Monet. Econ.13, 67–86 (1984)
Carlton, D. W.: The rigidity of prices. Amer. Econ. Rev.76, 637–58 (1986)
Cho, J. O.: Money, nominal contracts, and the business cycle: I. One-period contract case. Discussion Paper, Queen's University, 1990
Cho, J. O., Cooley, T. F. Employment and hours over the business cycle.” J. Econ. Dynam. Control. (1994)
Christiano, L. J., Eichenbaum, M.: Current real business cycle theory and aggregate labor market fluctuations. Amer. Econ. Rev.82, 430–50 (1992)
Cooley, T. F., Hansen, G. D.: Inflation tax in a real business cycle model. Amer. Econ. Rev.79, 733–748 (1989)
Cooley, T. F., Ohanian, L.: The cyclical behavior of prices. J. Monet. Econ.28, 25–60 (1991)
Cooley, T. F., Prescott, E. C.: Economic growth and business cycles. In: Cooley, T. F. (ed.) Frontiers of business cycle research. Princeton: Princeton University Press (1994)
Fischer, S.: Long-term contracts, rational expectations, and the optimal money supply rule. J. Polit. Econ.85, 191–206 (1977)
Friedman, M., Schwartz, A. J.: A monetary history of the United States, 1867–1960. Princeton: Princeton University Press (1963)
Gray, J. A.: Wage indexation: A macroeconomic approach. J. Monet. Econ.2, 221–235 (1976)
Gordon, R. J.: What is new-Keynesian economics?. J. Econ. L it.XXVIII 1115–71 (1990)
Hansen, G. D.: Indivisible labor and the business cycle. J. Mon. Econ.16, 309–28 (1985)
Keane, M. P.: Nominal contracting theories of unemployment: Evidence from panel data.Reproduced University of Minnesota (1990)
King, R. G.: Money and business cycles. Reproduced, University of Rochester (1990)
Kretzmer, P.: The cross-industry effects of unanticipated money in an equilibrium business cycle model. J. Monet. Econ.11, 73–88 (1989)
Kydland, F. E.: The role of money in a competitive model of business fluctuations. Reproduced, Carnegie-Mellon University (1989)
Kydland, F. E., Prescott, E. C.: Time to build and aggregate fluctuations. Econometrica,50, (1982)
Kydland, F. E., Prescott, E. C.: Hours and employment variation in business cycle theory. Econ. Theory1, 63–81 (1991)
Lucas, R. E., Jr.: Expectations and the neutrality of money J. Econ. Theory4, 103–123 (1972)
Lucas, R. E., Jr.: Models of business cycles. New York: Basil Blackwell (1987)
Lucas, R. E. Jr.: The effects of monetary shocks when prices are set in advance, reproduced.
Mankiw, N. G.: Small menu costs and large business cycles: A macroeconomic model of monopoly.Quart. J. Econ. 100, 529–39 (1985)
McCallum, B. T.: Monetary economics. New York: MacMillan Publishing Co. (1989)
Parkin, M.: The output inflation trade-off when prices are costly to change.J. Polit. Econ. 94, 200–24 (1986)
Prescott, E. C.: Theory ahead of business cycle measurement.Fed. Res. Bank Minn. Quart. Rev. 10, 9–22 (1986)
Prescott, E. C.: Real business cycle theory: What have we learned?Rev. Anal. Econ. 6 3–19 (1991)
Rotemberg, J. J.: The new Keynesian microfoundations. NBER Macroecon. Ann.1, 69–104 (1986)
Taylor, J.: Staggered price setting in a macro model,Amer. Econ. Rev. 69, 108–113 (1971)
Taylor, J.: Aggregate dynamics and staggered contractsJ. Polit. Econ. 88, 1–24 (1980)
Author information
Authors and Affiliations
Additional information
We have received helpful comments from David Chapman, Paul Gomme, Jeremy Greenwood, Gary Hansen, Michael Keane, Tim Kehoe, Lee Ohanian, Edward Prescott, and Warren Weber. The usual disclaimer applies. This research is supported in part by NSF Grant SES-8921346 and the John M. Olin Foundation.
Rights and permissions
About this article
Cite this article
Cho, JO., Cooley, T.F. The business cycle with nominal contracts. Econ Theory 6, 13–33 (1995). https://doi.org/10.1007/BF01213939
Received:
Revised:
Issue Date:
DOI: https://doi.org/10.1007/BF01213939