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Optimal Monetary Policy in the Presence of Human Capital Depreciation during Unemployment

Author

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  • Lien Laureys

    () (Bank of England
    Centre for Macroeconomics (CFM))

Abstract

When workers are exposed to human capital depreciation during periods of unemployment, hiring affects the unemployment pool’s composition in terms of skills, and hence the economy’s production potential. Introducing human capital depreciation during unemployment into an otherwise standard New Keynesian model with search frictions in the labour market leads to the finding that the flexible price allocation is no longer constrained-efficient even when the standard Hosios (1990) condition holds. This is because it generates a composition externality in job creation: firms ignore how their hiring decisions affect the extent to which the unemployed workers’ skills erode, and hence the output that can be produced by new matches. Consequently, it might be desirable from a social point of view for monetary policy to deviate from strict inflation targeting. Although optimal price inflation is no longer zero, strict inflation targeting is shown to stay close to the optimal policy.

Suggested Citation

  • Lien Laureys, 2014. "Optimal Monetary Policy in the Presence of Human Capital Depreciation during Unemployment," Discussion Papers 1415, Centre for Macroeconomics (CFM).
  • Handle: RePEc:cfm:wpaper:1415
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    References listed on IDEAS

    as
    1. Laureys, Lien, 2014. "The cost of human capital depreciation during unemployment," Bank of England working papers 505, Bank of England.
    2. Addison, John T & Portugal, Pedro, 1989. "Job Displacement, Relative Wage Changes, and Duration of Unemployment," Journal of Labor Economics, University of Chicago Press, vol. 7(3), pages 281-302, July.
    3. Faia, Ester, 2009. "Ramsey monetary policy with labor market frictions," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 570-581, May.
    4. Federico Ravenna & Carl E. Walsh, 2011. "Welfare-Based Optimal Monetary Policy with Unemployment and Sticky Prices: A Linear-Quadratic Framework," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(2), pages 130-162, April.
    5. Julen Esteban-Pretel & Elisa Faraglia, 2005. "Monetary Shocks in a Model with Loss of Skills," CIRJE F-Series CIRJE-F-380, CIRJE, Faculty of Economics, University of Tokyo.
    6. Laureys, Lien, 2014. "The cost of human capital depreciation during unemployment," LSE Research Online Documents on Economics 86337, London School of Economics and Political Science, LSE Library.
    7. Johannes F. Schmieder & Till von Wachter & Stefan Bender, 2013. "The Causal Effect of Unemployment Duration on Wages: Evidence from Unemployment Insurance Extensions," NBER Working Papers 19772, National Bureau of Economic Research, Inc.
    8. Ravenna, Federico & Walsh, Carl E., 2012. "Monetary policy and labor market frictions: A tax interpretation," Journal of Monetary Economics, Elsevier, vol. 59(2), pages 180-195.
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    Cited by:

    1. Ortego-Marti, Victor, 2017. "Differences in skill loss during unemployment across industries and occupations," Economics Letters, Elsevier, vol. 161(C), pages 31-33.
    2. Laureys, Lien, 2014. "The cost of human capital depreciation during unemployment," Bank of England working papers 505, Bank of England.
    3. Acharya, Sushant & Bengui, Julien & Dogra, Keshav & Wee, Shu Lin, 2017. "Escaping unemployment traps," Staff Reports 831, Federal Reserve Bank of New York.
    4. Sterk, Vincent, 2016. "The dark corners of the labor market," LSE Research Online Documents on Economics 86244, London School of Economics and Political Science, LSE Library.
    5. Angelopoulos, Konstantinos & Jiang, Wei & Malley, James, 2015. "Fiscal multipliers in a two-sector search and matching model," SIRE Discussion Papers 2015-67, Scottish Institute for Research in Economics (SIRE).
    6. Vincent Sterk, 2015. "The Dark Corners of the Labor Market," 2015 Meeting Papers 798, Society for Economic Dynamics.
    7. Laureys, Lien, 2014. "The cost of human capital depreciation during unemployment," LSE Research Online Documents on Economics 86337, London School of Economics and Political Science, LSE Library.
    8. Vincent Sterk, 2016. "The Dark Corners of the Labor Market," Discussion Papers 1603, Centre for Macroeconomics (CFM).

    More about this item

    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
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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