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Employment, Wages and Optimal Monetary Policy

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  • Martin Bodenstein
  • Junzhu Zhao

Abstract

We study optimal monetary policy when the empirical evidence leaves the policymaker uncertain whether the true data-generating process is given by a model with sticky wages or a model with search and matching frictions in the labor market. Unless the policymaker is almost certain about the search and matching model being the correct data-generating process, the policymaker chooses to stabilize wage inflation at the expense of price inflation, a policy resembling the policy that is optimal in the sticky wage model, regardless of the true model. This finding reflects the greater sensitivity of welfare losses to deviations from the model-specific optimal policy in the sticky wage model. Thus, uncertainty about important aspects of the structure of the economy does not necessarily translate into uncertainty about the features of good monetary policy.

Suggested Citation

  • Martin Bodenstein & Junzhu Zhao, 2017. "Employment, Wages and Optimal Monetary Policy," Finance and Economics Discussion Series 2017-091, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2017-91
    DOI: 10.17016/FEDS.2017.091
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    File URL: https://www.federalreserve.gov/econres/feds/files/2017091pap.pdf
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    References listed on IDEAS

    as
    1. J. Tetlow, Robert & von zur Muehlen, Peter, 2001. "Robust monetary policy with misspecified models: Does model uncertainty always call for attenuated policy?," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 911-949, June.
    2. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-132, March.
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    More about this item

    Keywords

    Model uncertainty ; Optimal monetary policy ; Optimal targeting rules ; Search and matching ; Sticky wages;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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