Downward wage rigidity and optimal steady-state inflation

This paper examines the impact of downward wage rigidity (nominal and real) onoptimal steady-state inflation. For this purpose, we extend the workhorse model ofErceg, Henderson and Levin (2000) by introducing asymmetric menu costs for wagesetting. We estimate the key parameters by simulated method of moments, matchingkey features of the cross-sectional distribution of individual wage changes observed inthe data. We look at five countries (the US, Germany, Portugal, Belgium andFinland). The calibrated heterogeneous agent models are then solved for differentsteady state rates of inflation to derive welfare implications. We find that, across theEuropean countries considered, the optimal...