Inequality, Nominal Rigidities, and Aggregate Demand

This paper studies the role of wage and price rigidities in determining aggregate demand. With incomplete markets, real wages determine consumption. In response to shocks, wages and prices may not respond evenly, affecting how shocks transmit to aggregate demand. Motivated by these observations, we revisit the gains from wage flexibility for output stabilization and find that the relative fluctuations of wages and prices matter. We contribute with three results. First, that wage flexibility generates an excessive response of aggregate demand to aggregate shocks if prices are sufficiently sticky. Second, given wage rigidities, higher price stickiness makes the inversion of the IS more likely. And third, monetary policy should respond to wages if prices are relatively stickier