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Unemployment fluctuations, and optimal monetary policy in a small open economy

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  • Hyuk Jae Rhee

    ()
    (Department of Economics, University of Windsor)

  • Jeongseok Song

    ()
    (Department of Economics,Chung-Ang University)

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    Abstract

    In this paper, we incorporate key ingredients of a small open economy into the New Keynesian model with unemployment of Gali (2011a,b) to discuss the design of the monetary policy. The main findings regarding the issue of monetary policy design can be summarized as threefold. First, the optimal policy is to seek to minimize variance of domestic price inflation, wage inflation, and the output gap if both domestic price and wage are sticky. Second, stabilizing unemployment rate is important to reduce the welfare loss incurred by both technology and labor supply shocks. Therefore, introducing the unemployment rate as an another argument into the Taylor-rule type interest rate rule will be welfare-enhancing. Last, controlling CPI inflation is the best when the policy is not allowed to respond to unemployment rate.

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    File URL: http://web2.uwindsor.ca/economics/RePEc/wis/pdf/1309.pdf
    File Function: First version, 2013
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    Bibliographic Info

    Paper provided by University of Windsor, Department of Economics in its series Working Papers with number 1309.

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    Length: 31 pages
    Date of creation: 28 Aug 2013
    Date of revision:
    Handle: RePEc:wis:wpaper:1309

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    Keywords: Unemployment; Monetary policy; Small open economy.;

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    1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 2002. "A Simple Framework for International Monetary Policy Analysis," CEPR Discussion Papers 3355, C.E.P.R. Discussion Papers.
    2. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
    3. Carlos Thomas, 2006. "Search and matching frictions and optimal monetary policy," LSE Research Online Documents on Economics 19782, London School of Economics and Political Science, LSE Library.
    4. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
    5. Faia, Ester, 2007. "Ramsey monetary policy with labour market frictions," Working Paper Series 0707, European Central Bank.
    6. Olivier Blanchard & Jordi Galí, 2006. "Labor markets and monetary policy: A new-Keynesian model with unemployement," Economics Working Papers 1076, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 2008.
    7. Karlygash Kuralbayeva, 2011. "Inflation Persistence and Exchange Rate Regime: Implications for dynamic adjustment to shocks in a small open economy," OxCarre Working Papers 063, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
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