Optimal prudential policy in economies with downward wage rigidity

This paper studies optimal policy in economies with downward nominal wage rigidity when only prudential instruments are available. The optimal policy reduces labor demand in expansions as this curtails unemployment in ecessions. The cost of the intervention is that in expansions, the economy produces below potential. We characterize this trade-off theoretically and quantitatively by applying our model to Greece, 1999-2016. We find that the optimal prudential policy would have significantly reduced Greek unemployment after the downturn in 2008. Furthermore, we find large welfare gains of the optimal prudential policy, removing about one fourth of the total welfare cost of downward wage rigidity.