Optimal Monetary Policy in the Presence of Human Capital Depreciation during Unemployment
AbstractWhen workers are exposed to human capital depreciation during periods of unemployment, hiring affects the unemployment pool’s composition in terms of skills, and hence the economy’s production potential. Introducing human capital depreciation during unemployment into an otherwise standard New Keynesian model with search frictions in the labour market leads to the finding that the flexibleprice allocation is no longer constrained-efficient even when the standard Hosios (1990) condition holds. This is because it generates a composition externality in job creation: firms ignore how their hiring decisions affect the extent to which the unemployed workers’ skills erode, and hence the output that can be produced by new matches. Consequently, it might be desirable from a social point of view for monetary policy to deviate from strict inflation targeting. Although optimal price inflation is no longer zero, strict inflation targeting is shown to stay close to the optimal policy.
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Bibliographic InfoPaper provided by Centre for Macroeconomics (CFM) in its series Discussion Papers with number 1415.
Length: 46 pages
Date of creation: Jun 2014
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-07-05 (All new papers)
- NEP-CBA-2014-07-05 (Central Banking)
- NEP-DGE-2014-07-05 (Dynamic General Equilibrium)
- NEP-MAC-2014-07-05 (Macroeconomics)
- NEP-MON-2014-07-05 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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