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Uninsured Unemployment Risk and Optimal Monetary Policy

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  • Edouard Challe

    () (CREST; CNRS; Ecole Polytechnique)

Abstract

I study optimal monetary policy in a New Keynesian economy wherein households precautionary-save against uninsured, endogenous unemployment risk. In this economy greater unemployment risk raises desired savings, causing aggregate demand to fall and feedback to greater unemployment risk. I show this de?flationary feedback loop to be constrained-inefficient and to call for an accommodative monetary policy response: after a contractionary aggregate shock the policy rate should be kept signifi?cantly lower and for longer than in the perfect-insurance benchmark. For example, the usual prescription obtained under perfect insurance of a hike in the policy rate in the face of a bad supply (i.e., productivity or cost-push) shock is easily overturned. If implemented, the optimal policy effectively breaks the defl?ationary feedback loop and takes the dynamics of the imperfect-insurance economy close to that of the perfect-insurance benchmark.

Suggested Citation

  • Edouard Challe, 2017. "Uninsured Unemployment Risk and Optimal Monetary Policy," Working Papers 2017-54, Center for Research in Economics and Statistics.
  • Handle: RePEc:crs:wpaper:2017-54
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    References listed on IDEAS

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    Cited by:

    1. Mengus, Eric & Barthelemy, Jean, 2017. "Monetary Rules, Determinacy and Limited Enforcement," HEC Research Papers Series 1202, HEC Paris, revised 11 May 2019.
    2. Cui, Wei & Sterk, Vincent, 2018. "Quantitative easing," LSE Research Online Documents on Economics 90874, London School of Economics and Political Science, LSE Library.
    3. Florin Bilbiie & Xavier Ragot, . "Optimal Monetary Policy and Liquidity with Heterogeneous Households," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    4. Cui, Wei & Sterk, Vincent, 2018. "Quantitative Easing," CEPR Discussion Papers 13322, C.E.P.R. Discussion Papers.
    5. Wei Cui & Vincent Sterk, 2018. "Quantitative Easing," Discussion Papers 1830, Centre for Macroeconomics (CFM).
    6. Xavier Ragot, 2018. "Limited Participation, Capital Accumulation and Optimal Monetary Policy," Sciences Po Economics Discussion Papers 2018-12, Sciences Po Departement of Economics.
    7. Vincent Sterk & Wei Cui, 2019. "Quantitative Easing," 2019 Meeting Papers 29, Society for Economic Dynamics.

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    More about this item

    Keywords

    Unemployment risk; imperfect insurance; optimal monetary policy;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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