What do nonrational behaviors imply about the price stability goal of monetary policy?
The authors repeat the familiar argument that resistance to nominal wage reductions owing to money illusion and nominal loss aversion on the part of workers justifies the settings of monetary policy in its inflation target appreciably above zero to facilitate employers’ ability to cut real wages. However, the evidence on this point isn’t nearly as overwhelming as B&L suggest. With inflation much lower than the authors’ suggestion of 3 percent and continuing to decline, we’re in the midst of a natural experiment. So far at least, real wage increases have not been markedly higher than would have been predicted based on models fit over periods of more rapid inflation. And inflation has been coming down somewhat more rapidly than our models expect given the level of the unemployment rate. Preliminary work by Bill Wascher and Bruce Fallick on the Board staff using micro data from the Employment Cost Index does show a piling up of wage changes at zero each year that affect perhaps an extra 1
