Exercise 11.2

Welfare Cost of Lack of Credibility with Wage Rigidity

⬅ Return

Problem

Modify the economy of exercise 11.1 by introducing downward nominal wage rigidity as in Chapter 9. Specifically, assume that \(W_t\ge W_{t-1}\) for all \(t\ge 0\).

Answer the questions of exercise 11.1 in this new environment. To this end, first compute \(W_{-1}\) under the assumption that before period 0 the economy was in a steady state with constant consumption of tradables and nontradables, full employment, no debt, and a nominal exchange rate equal to unity.

Answer

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