Real wage rigidity drives policy pivot for persistent supply shocks
A Banque de France working paper by Stéphane Dupraz examines why central banks adopt tighter monetary policies during persistent supply shocks. The author demonstrates that real wage rigidity, rather than the risk of de-anchoring inflation expectations, drives this policy shift.
The missing link in macroeconomic models
Central banks traditionally respond to persistent supply shocks by prioritizing inflation stabilization to prevent inflation expectations from de-anchoring.
Yet, standard macroeconomic models fail to justify this heuristic for common supply shocks such as productivity, labor supply, or energy price disturbances.
In these models, stabilizing the output gap remains close to optimal regardless of shock persistence.
Stéphane Dupraz demonstrates that neither rational nor adaptive expectations alter this fundamental conclusion for non-markup shocks.
Why real wage rigidity changes the math
The paper identifies real wage rigidity as the decisive mechanism that rationalizes a tighter policy pivot.
When nominal wages stubbornly catch up with prices to protect purchasing power, stabilizing the output gap becomes significantly more costly.
Under these conditions, price and wage inflation move in the same direction, compelling monetary authorities to tolerate a negative output gap to contain broader inflationary pressures.
Monitoring wage rigidity thus emerges as crucial.
Beyond the inflation obsession
This study upends conventional central banking wisdom by shifting the focus from inflation expectations to labor market structures.
By proving that wage rigidity forces policy shifts, it offers a rigorous theoretical foundation for pragmatic policy heuristics.
Policymakers ignoring real wage dynamics do so at their own peril.