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Monetary Policy in the presence of Informal Labour Markets

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  • Castillo, Paul

    (Banco Central de Reserva del Perú)

  • Montoro, Carlos

    (Banco Central de Reserva del Perú and Bank for International Settlements)

Abstract

In this paper we analyse the effects of informal labour 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 labour 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 aggregate wages and inflation. Finding that is consistent with the empirical literature on the e¤ects of informal labour markets in business cycle fluctuations. This result implies that in economies with large informal labour 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

Paper provided by Banco Central de Reserva del Perú in its series Working Papers with number 2010-009.

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Date of creation: Jul 2010
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Handle: RePEc:rbp:wpaper:2010-009

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Keywords: Monetary Policy; New Keynesian Model; Informal Economy; Labour Market Frictions.;

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References

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  1. Fugazza, Marco & Jacques, Jean-Francois, 2004. "Labor market institutions, taxation and the underground economy," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 395-418, January.
  2. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation stabilization and welfare: The case of a distorted steady state," Discussion Papers 0405-04, Columbia University, Department of Economics.
  3. Tito Boeri & Pietro Garibaldi, 2005. "Shadow Sorting," NBER Chapters, in: NBER International Seminar on Macroeconomics 2005, pages 125-163 National Bureau of Economic Research, Inc.
  4. Trigari, Antonella, 2004. "Equilibrium unemployment, job flows and inflation dynamics," Working Paper Series 0304, European Central Bank.
  5. Mark Gertler & Antonella Trigari, 2006. "Unemployment Fluctuations With Staggered Nash Wage Bargaining," NBER Working Papers 12498, National Bureau of Economic Research, Inc.
  6. Kolm, Ann-Sofie & Larsen, Birthe, 2006. "Does Tax Evasion Affect Unemployment and Educational Choice?," Working Papers 12-2003, Copenhagen Business School, Department of Economics.
  7. Thomas Lubik & Michael Krause, 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Economics Working Paper Archive 504, The Johns Hopkins University,Department of Economics.
  8. Maurizio Bovi, 2007. "Shadow Employment and Labor Productivity Dynamics," LABOUR, CEIS, vol. 21(4-5), pages 735-761, December.
  9. Carillo, Maria Rosaria & Pugno, Maurizio, 2004. "The underground economy and underdevelopment," Economic Systems, Elsevier, vol. 28(3), pages 257-279, September.
  10. Ravenna, Federico & Walsh, Carl E., 2008. "Vacancies, unemployment, and the Phillips curve," European Economic Review, Elsevier, vol. 52(8), pages 1494-1521, November.
  11. Mariano Bosch, 2006. "Job Creation and Job Destruction in the Presence of Informal Labour Markets," CEP Discussion Papers dp0761, Centre for Economic Performance, LSE.
  12. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
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Cited by:
  1. Batini, Nicoletta & Levine, Paul & Lotti, Emanuela & Yang, Bo, 2011. "Monetary and Fiscal Policy in the Presence of Informal Labour Markets," Working Papers 11/97, National Institute of Public Finance and Policy.
  2. Nicoletta Batini & Young-Bae Kim & Paul Levine & Emanuela Lotti, 2009. "Informal Labour and Credit Markets: A Survey," School of Economics Discussion Papers 0609, School of Economics, University of Surrey.
  3. Ahmed, Shahzad & Ahmed, Waqas & Khan, Sajawal & Pasha, Farooq & Rehman, Muhammad, 2012. "Pakistan Economy DSGE Model with Informality," MPRA Paper 53135, University Library of Munich, Germany.
  4. Nicoletta Batini & Paul Levine & Emanuela Lotti, 2011. "The Costs and Benefits of Informality," School of Economics Discussion Papers 0211, School of Economics, University of Surrey.
  5. Giuseppe Ciccarone & Francesco Giuli & Enrico Marchetti, 2012. "Underground labor, search frictions and macroeconomic fluctuations," Departmental Working Papers of Economics - University 'Roma Tre' 0159, Department of Economics - University Roma Tre.
  6. SENBATA, Sisay Regassa, 2011. "How applicable are the new Keynesian DSGE models to a typical low-income economy?," Working Papers 2011016, University of Antwerp, Faculty of Applied Economics.
  7. Nicoletta Batini & Paul Levine & Emanuela Lotti & Bo Yang, 2011. "Informality, Frictions and Monetary Policy," School of Economics Discussion Papers 0711, School of Economics, University of Surrey.
  8. Emilio Colombo & Luisanna Onnis & Patrizio Tirelli, 2013. "Shadow economies at times of banking crises: empirics and theory," Working Papers 234, University of Milano-Bicocca, Department of Economics, revised Feb 2013.

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