Rule‐of‐Thumb Consumers Meet Sticky Wages

Abstract

It has been argued that rule‐of‐thumb consumers substantially alter the determinacy properties of interest rate rules and the dynamics of an otherwise standard New Keynesian model. In this paper, we show that nominal‐wage stickiness helps to restore standard results. The key findings are that when wages are sticky: (i) the Taylor Principle is re‐established as the necessary condition for equilibrium determinacy, and (ii) consumption rises in response to an innovation in government spending if monetary policy is characterized by interest rate smoothing and by a moderately anti‐inflationary stance. Our results help to explain the reduction in the expansionary effects of fiscal shocks observed in the United States since 1980.

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