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Inflation Dynamics in the Presence of Informal Labour Markets

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  • Paul Castillo B.
  • Carlos Montoro Ll.

Abstract

We analyze the effects of informal labor markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks. In doing so, we incorporate the informal sector in a modified New Keynesian model with labor market frictions as in the Diamond-Mortensen-Pissarides model. Our main results show that the informal economy generates a "buffer" effect that diminishes the pressure of demand shocks on inflation. Finding that is consistent with the empirical literature on the effects of informal labor markets in business cycle fluctuations. This result implies that in economies with large informal labor markets the interest rate channel of monetary policy is relatively weaker. Furthermore, the model produces cyclical flows from informal to formal employment consistent with the data.

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Bibliographic Info

Article provided by Central Bank of Chile in its journal Economía Chilena.

Volume (Year): 15 (2012)
Issue (Month): 1 (April)
Pages: 4-31

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Handle: RePEc:chb:bcchec:v:15:y:2012:i:1:p:4-31

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Cited by:
  1. SENBETA, Sisay Regassa, 2013. "Informality and macroeconomic fluctuations: A small open economy New Keynesian DSGE model with dual labour markets," Working Papers 2013002, University of Antwerp, Faculty of Applied Economics.

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