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Supply shocks, employment gap, and monetary policy

Author

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  • Kurozumi, Takushi
  • Van Zandweghe, Willem

Abstract

How should monetary policy respond to supply shocks in terms of inflation and employment stabilization? We introduce labor force entry and exit in an otherwise standard model with staggered price- and wage-setting to include employment in the model. A welfare-maximizing policy features wage growth stabilization with variation in the employment gap and inflation. Under staggered price- and wage-setting, the real wage adjustments to shocks entail a welfare cost, and variation in the employment gap contributes to reducing the welfare cost. Therefore, leaning against the employment gap induces substantial welfare losses for supply shocks compared to the welfare-maximizing policy.

Suggested Citation

  • Kurozumi, Takushi & Van Zandweghe, Willem, 2025. "Supply shocks, employment gap, and monetary policy," European Economic Review, Elsevier, vol. 177(C).
    • Handle: RePEc:eee:eecrev:v:177:y:2025:i:c:s0014292125000996
    DOI: 10.1016/j.euroecorev.2025.105049
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    More about this item

    Keywords

    Labor force entry and exit; Extensive margin of labor; Staggered price- and wage-setting; Wage growth stabilization;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • J21 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Force and Employment, Size, and Structure

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