International heterogeneity of nominal wages and optimal monetary policy

• Published date: 01 August 2023
• Author: Daisuke Ida,Mitsuhiro Okano
• Date: 01 August 2023
• DOI: http://doi.org/10.1111/infi.12429

Received: 15 October 2021

|

Accepted: 30 December 2022

DOI: 10.1111/infi.12429

ORIGINAL ARTICLE

International heterogeneity of nominal wages

and optimal monetary policy

Daisuke Ida

1,2

|Mitsuhiro Okano

3

1

Faculty of Economics, Momoyama

Gakuin University, Izumi, Osaka, Japan

2

Graduate School of Economics, Kobe

University, Kobe, Japan

3

Faculty of Economics, Osaka Gakuin

University, Suita, Osaka, Japan

Correspondence

Daisuke Ida, Faculty of Economics,

Momoyama Gakuin University, 1‐1,

Manabino, Izumi, Osaka 594‐1198,

Japan.

Email: ida-dai@andrew.ac.jp

Funding information

Japan Society for the Promotion of

Science, Grant/Award Numbers:

JP16H03618, JP20K01784, JP20K13531

Abstract

This paper examines optimal monetary policy in a two‐

country model with staggered nominal prices and

wages. We show that given home nominal wage

stickiness, changes in the degree of foreign nominal

wage stickiness substantially impact the worldwide

welfare losses and gains from commitment policy.

Specifically, the welfare gains from a commitment

policy are greatest when nominal wages in both

countries are perfectly flexible. However, when nomi-

nal wages in the foreign country are stickier, the gains

from commitment decrease.

KEYWORDS

commitment, discretion, nominal wage stickiness, optimal

monetary policy

JEL CLASSIFICATION

E52, E58, F41

1|INTRODUCTION

This paper aims to examine the effects of sticky nominal wages on optimal monetary policy in a

two‐country new Keynesian (NK) model. The effect of nominal wage stickiness on

macroeconomic fluctuation has been addressed by many studies (Christiano et al., 2005;

Smets & Wouters, 2003). Furthermore, we observe that advanced economies' international

trade and finance have expanded rapidly and globally. As shown in Figure 1, we point out that

heterogeneous behaviours of nominal wages are observed in advanced countries. This implies

that, as countries' international linkages through trade and finance have strengthened, policy

makers should consider the impact of international nominal wage heterogeneities on

macroeconomic fluctuations in each country. In fact, Galí and Monacelli (2016) argued that

a decline in the home country's wage leads to a depreciation in terms of trade, which prompts

International Finance. 2023;26:112–138.wileyonlinelibrary.com/journal/infi112

|

© 2023 John Wiley & Sons Ltd.

increases in its output and employment. In addition, Palomino et al. (2020) pointed out the

effect of the lockdown and social distancing measures prompted by coronavirus disease 2019

(COVID‐19)—induced shocks on wage inequality in Europe.

1

These pieces of evidence allow us

to construct a two‐country model with sticky nominal prices and wages.

To the best of our knowledge, this is the first study to examine the role of nominal wage

stickiness in a two‐country NK model. More specifically, this paper develops a two‐country

model with international heterogeneity of nominal wages and examines its impact under

international monetary policy coordination. Regarding the theoretical background of this

study, we bring up the assertion of Keynes (1936), who addressed the effect of nominal wage

stickiness on macroeconomic fluctuations. Obstfeld and Rogoff (2000) developed the two‐

country new open macroeconomic model (NOEM) with nominal wage stickiness in the spirit

of Keynes (1936). In their model, nominal wage stickiness is set only for one period, whereas

recentstudieshavehighlightedtheimportanceofintroducingnominalwagestickiness

(Christiano et al., 2005; Erceg et al., 2000;Galí,2011; Smets & Wouters, 2003). In particular,

Erceg et al. (2000) showed that the price inflation target is no longer optimal in a model with

staggered prices and wages, but this issue cannot be considered in the framework of Obstfeld

and Rogoff (2000).

2

Moreover, as shown in Figure 1, such a model cannot consider the

international heterogeneity of nominal wages. Accordingly, we can justify our two‐country

model with international heterogeneity of nominal wages in terms of empirical and

theoretical aspects.

This study contributes to previous research in the following ways. First, we constructed a

two‐country model with sticky nominal prices and wages. More specifically, we incorporate the

idea suggested by Erceg et al. (2000) into the two‐country NK model developed by Clarida et al.

(2002).

3

Second, we calculate the central bank's loss function using a quadratic approximation

of the household utility function under international policy coordination and the gains from a

commitment policy. As far as we know, this is the first study to investigate gains from

commitments under monetary policy coordination.

FIGURE 1 Growth rates of average annual wages. Average wages are converted in USD PPPs using 2020

USD PPPs for private consumption. Source: OECD database. [Color figure can be viewed at

wileyonlinelibrary.com]

IDA and OKANO

|

113