Interactions between Labor Market Reforms and Monetary Policy under Slowly Changing Habits
AbstractAlthough central banks often advocate labor market reforms, the latter may lead to higher stabilization costs in the presence of habit persistence in consumption. This is more likely to occur when strong habit persistence is coupled with an inflation-averse central bank. The presence of habit formation is a non-negligible assumption: theoretically, it is now a well-established device used in New-Keynesian models in order to be data-consistent with the response of real spending to several shocks. Moreover, estimates of habit formation are, according to the literature, quite large. To capture the interactions between monetary policy and structural reforms, our model improves on the one presented in Aguiar and Ribeiro (2008) by including a job matching process that introduces additional labor market features through which a labor market reform can operate. Within this framework, we assess, across different policy rules, how labor market institutional changes impinge on the effectiveness of monetary policy. We have concluded that labor market reform reduces central banks' losses, as long as the degree of habit persistence is not too strong; however, alternative reform devices impinge differently on monetary policy effectiveness. Moreover, the inflation targeting rule accommodates positive permanent effects from the reform for a wider range of habit persistence. Even when habit persistence is high, reform may still reduce stabilization costs if the importance of both demand and technology shocks is low relative to cost-push ones.
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Bibliographic InfoPaper provided by Universidade do Porto, Faculdade de Economia do Porto in its series FEP Working Papers with number 309.
Length: 21 pages
Date of creation: Jan 2009
Date of revision:
Monetary policy rules; Labor market reform; Labor market search and matching; New-Keynesian models;
Find related papers by JEL classification:
- E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
- E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-01-31 (All new papers)
- NEP-DGE-2009-01-31 (Dynamic General Equilibrium)
- NEP-LAB-2009-01-31 (Labour Economics)
- NEP-MAC-2009-01-31 (Macroeconomics)
- NEP-MON-2009-01-31 (Monetary Economics)
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- Joana Almodovar & Aurora A.C. Teixeira, 2009. "Conceptualizing clusters through the lens of networks: a critical synthesis," FEP Working Papers 328, Universidade do Porto, Faculdade de Economia do Porto.
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