Staggered Wages and Disinflation Dynamics: What Can More Microfoundations Tell Us?

We study the output costs of a reduction in monetary growth in a dynamic general equilibrium model with staggered wages. As in John Taylor’s approach, the money wage is fixed for two periods, but in our model it is also chosen according to intertemporal optimization, as are consumption and money demand. Agents have labour market monopoly power. We show that the introduction of microfoundations helps to resolve the puzzle recently raised by Laurence Ball, namely that disinflation in staggered pricing models causes a boom. In our model disinflation, whether unanticipated or anticipated, unambiguously causes a slump.