December 1, 2002
This paper offers a reappraisal of the inflation-unemployment tradeoff, based on "frictional growth," describing the interplay between nominal frictions and money growth. When the money supply grows in the presence of price inertia (due to staggered wage contracts with time discounting), the price adjustments to each successive change in the money supply are never able to work themselves out fully. In this context, monetary shocks have a gradual and delayed effect on inflation, and these shocks also generate plausible impulse-responses for unemployment. Although our theory contains no money illusion, no permanent nominal rigidities, and no departure from rational expectations, there is a long-run inflation-unemployment tradeoff.
J.E.L classification codes: E2, E3, E4, E5, J3
Keywords:Inflation, Unemployment, Phillips curve, Nominal inertia, Wage-price staggering, Monetary policy, Business cycles, Forward-looking expectations