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Optimal monetary policy rules with labor market frictions

  • Faia, Ester

This paper studies optimal monetary policy rules in a framework with sticky prices, matching frictions and real wage rigidities. Optimal policy is given by a constrained Ramsey plan in which the monetary authority maximizes the agents' welfare subject to the competitive economy relations and the assumed monetary policy rule. I find that the optimal rule should respond to unemployment alongside with inflation. This is so since models with matching frictions (unlike standard new Keynesian models) feature a congestion externality that makes unemployment inefficiently high. A strong response to inflation remains optimal while a response to output is always welfare detrimental.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 32 (2008)
Issue (Month): 5 (May)
Pages: 1600-1621

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Handle: RePEc:eee:dyncon:v:32:y:2008:i:5:p:1600-1621
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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