A Generalized New Keynesian Model with Wage Stickiness

Abstract

In this paper, we derive a generalized version of New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to study how real imperfections of labor market affect the steady state and dynamics of model given different non-zero annual target inflation rates. The main finding is that, given the same target inflation rate, wage stickiness is more distortionary than the price stickiness. The existence of positive target inflation rate can also change the first-order dynamics of model, amplifying or reducing the dynamic response of model according to the type of exogenous shocks. A relatively high target inflation rate, 2% or 3%, may be preferable to a zero target inflation rate.