Workers , Capitalists , Wages , and Employment ∗

Standard new Keynesian models assume the functional distribution of income is irrelevant. This stands in contrast to much of the public debate which presumes that a shift in the distribution of income towards workers will boost aggregate demand and employment. Under this latter view, falling wages during a recession can worsen unemployment. In contrast, neoclassical economics often views unemployment as a direct reflection of the failure of wages to fall. In this paper, I construct a sticky-price, sticky-wage model of workers and capitalists in which the functional distribution of income matters. Wage income directly affects aggregate demand. I derive a second order approximation to social welfare and show the welfare consequences of greater wage flexibility depends critically on monetary policy and the relative importance of different sources of economic fluctuations.