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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

In this paper, we derive a linear-quadratic model for monetary policy analysis 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 the costs of fluctuations 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 use the model to analyze optimal monetary policy under commitment and discretion and to show that the structural characteristics of the labor market have important implications for optimal policy.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2009-15.

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Date of creation: 2009
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Handle: RePEc:fip:fedfwp:2009-15

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Keywords: Monetary policy ; Econometric models;

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  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. Mariya Mileva, 2013. "Optimal Monetary Policy in Response to Shifts in the Beveridge Curve," Kiel Working Papers 1823, Kiel Institute for the World Economy.
  2. Stéphane Auray & Aurélien Eyquem, 2012. "Welfare Reversal in Monetary Union," Working Papers 2012-33, Centre de Recherche en Economie et Statistique.
  3. 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.
  4. Sergio A. Lago Alves, 2012. "Trend Inflation and the Unemployment Volatility Puzzle," Working Papers Series 277, Central Bank of Brazil, Research Department.
  5. 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.
  6. 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.
  7. 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.
  8. Alessia Campolmi & Stefano Gnocchi, 2014. "Labor Market Participation, Unemployment and Monetary Policy," Working Papers 14-9, Bank of Canada.
  9. 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.
  10. Sanjay Chugh & Christian Merkl, 2011. "Efficiency in a Model of Labor Selection," Kiel Working Papers 1684, Kiel Institute for the World Economy.

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