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Uninsured Unemployment Risk and Optimal Monetary Policy

Author

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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

    as
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    More about this item

    Keywords

    Unemployment risk; imperfect insurance; optimal monetary policy;

    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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