Stabilisation, Policy Targets and Unemployment in Imperfectly Competitive Economies
This paper argues that the rate of equilibrium unemployment depends on the objectives of the central bank. In a model where the central bank uses monetary policy to stabilize the economy, the authors show that unemployment and inflation will be lower with an inflation target than with targets for output, money, or nominal GDP. The intuition for this is that the elasticities of demand in both the product and the labor markets are greater when there is an inflation target; they show that this leads to a lower mark-up of price over marginal cost and makes wages more sensitive to unemployment. Copyright 1999 by The editors of the Scandinavian Journal of Economics.
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