Tobin's proposition that inflation "greases" the wheels of the labor market is studied using a simple dynamic stochastic general equilibrium model with asymmetric wage adjustment costs. The simulated method of moments is used to estimate the nonlinear model based on its second-order approximation. Optimal inflation is determined by a benevolent government that maximizes the households' welfare. Econometric results indicate that nominal wages are downwardly rigid and that the optimal level of grease inflation for the U.S. economy is about 0.35% per year, with a 95% confidence interval ranging from 0.04% to 0.87%.
Bibliographical noteFunding Information:
We received helpful comments and suggestions from Klaus Adam, Michelle Alexopoulos, Paul Beaudry, Craig Burnside, Gauti Eggertsson, Steinar Holden, Junhan Kim, Emi Nakamura, Angelo Melino, Giorgio Primiceri, the editor (Robert King), and an anonymous referee. The first author thanks CIREQ and the Department of Economics of the University of Montréal for their hospitality. This research received the financial support of the Social Sciences and Humanities Research Council of Canada.
- Asymmetric adjustment costs
- Downward wage rigidity
- Nonlinear dynamics
- Optimal inflation
ASJC Scopus subject areas
- Economics and Econometrics