Downward Nominal Wage Rigidity and Inflation Dynamics During and After the Great Recession

Abstract

I develop a New Keynesian model that embeds heterogeneous workers with asymmetric wage adjustment costs in order to address two inflation puzzles: missing deflation during the Great Recession and the subsequent missing inflation. Downward nominal wage rigidity endogenously arises when the wage adjustment costs are estimated according to U.S. micro wage data, generating the flattening of the observed price Phillips curve during and after recessions. Endogenous evolution of the cross-sectional wage distribution generates nonlinear dynamics such as the sign-, size-, and state-dependence. These nonlinearities help the model address the inflation puzzles as well as matching micro evidence on wage adjustments.