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Welfare-Based Optimal Monetary Policy with Unemployment and Sticky Prices: A Linear-Quadratic Framework

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  • Federico Ravenna
  • Carl E. Walsh

Abstract

We derive a linear-quadratic model that is consistent with sticky prices and search and matching frictions in the labor market. We show that the second-order approximation to the welfare of the representative agent depends on inflation and "gaps" that involve current and lagged unemployment. Our approximation makes explicit how welfare costs are generated by the presence of search frictions. These costs are distinct from the costs associated with relative price dispersion and fluctuations in consumption that appear in standard new Keynesian models. We show the labor market structure has important implications for optimal monetary policy. (JEL E24, E31, E52)

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 3 (2011)
Issue (Month): 2 (April)
Pages: 130-62

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Handle: RePEc:aea:aejmac:v:3:y:2011:i:2:p:130-62

Note: DOI: 10.1257/mac.3.2.130
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Blog mentions

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  1. Connecting the Academic and Policy Worlds: Interview with James Bullard
    by David Andolfatto in MacroMania on 2013-11-25 21:40:00
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Cited by:
  1. Stéphane Auray & Aurélien Eyquem, 2012. "Welfare Reversal in Monetary Union," Working Papers 2012-33, Centre de Recherche en Economie et Statistique.
  2. Sergio A. Lago Alves, 2012. "Trend Inflation and the Unemployment Volatility Puzzle," Working Papers Series 277, Central Bank of Brazil, Research Department.
  3. Mariya Mileva, 2013. "Optimal Monetary Policy in Response to Shifts in the Beveridge Curve," Kiel Working Papers 1823, Kiel Institute for the World Economy.
  4. Abbritti, Mirko & Fahr, Stephan, 2013. "Downward wage rigidity and business cycle asymmetries," Journal of Monetary Economics, Elsevier, vol. 60(7), pages 871-886.
  5. Kurozumi, Takushi & Van Zandweghe, Willem, 2012. "Learning about monetary policy rules when labor market search and matching frictions matter," Journal of Economic Dynamics and Control, Elsevier, vol. 36(4), pages 523-535.
  6. Sanjay Chugh & Christian Merkl, 2011. "Efficiency in a Model of Labor Selection," Kiel Working Papers 1684, Kiel Institute for the World Economy.
  7. Alessia Campolmi & Stefano Gnocchi, 2014. "Labor Market Participation, Unemployment and Monetary Policy," Working Papers 14-9, Bank of Canada.
  8. Francesco Furlanett & Nicolas Groshenny, 2012. "Matching efficiency and business cycle fluctuations," Reserve Bank of New Zealand Discussion Paper Series DP2012/06, Reserve Bank of New Zealand.
  9. Ko Munakata & Koji Nakamura & Yuki Teranishi, 2013. "Optimal Macroprudential Policy," CAMA Working Papers 2013-51, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  10. Lien Laureys, 2014. "Optimal Monetary Policy in the Presence of Human Capital Depreciation during Unemployment," Discussion Papers 1415, Centre for Macroeconomics (CFM).
  11. Raissi, M., 2011. "A Linear Quadratic Approach to Optimal Monetary Policy with Unemployment and Sticky Prices: The Case of a Distorted Steady State," Cambridge Working Papers in Economics 1146, Faculty of Economics, University of Cambridge.
  12. Tang, Jenn-Hong, 2010. "Optimal monetary policy in a new Keynesian model with job search," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 330-353, March.

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