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Abstract:
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We introduce efficiency wages into a sticky price dynamic general equilibrium model with incomplete markets. The incompleteness here is in the risk sharing arrangement between the employed and the unemployed. The model is motivated in part by the fact that monetary policy in conventional sticky wage models derives much of its power through real wage fluctuations. In the data, the response of real wages to an expansionary monetary shock is either zero, or a mild decline, as shown in Christiano, Eichenbaum, and Evans (1997). We first show that an efficiency wage model provides better fit for the data, by estimating the model using nonlinear Bayesian estimation methods. We then derive monetary policy rules for this environment.
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