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Learning about monetary policy rules when labor market search and matching frictions matter

  • Takushi Kurozumi
  • Willem Van Zandweghe

This paper examines implications of incorporating labor market search and matching frictions into a sticky price model for determinacy and E-stability of rational expectations equilibrium (REE) under interest rate policy. When labor adjustment takes place solely at the extensive margin, forecast-based policy that meets the Taylor principle is likely to induce indeterminacy and E-instability, regardless of whether it is strictly or flexibly inflation targeting. When labor adjustment takes place at both the extensive and intensive margins, the strictly inflation-forecast targeting policy remains likely to induce indeterminacy, but it generates a unique E-stable fundamental REE as long as the Taylor principle is satisfied. These results suggest that introducing the search and matching frictions alter determinacy properties of the strictly inflation-forecast targeting policy, but not its E-stability properties in the presence of the intensive margin of labor.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 10-14.

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Date of creation: 2010
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Handle: RePEc:fip:fedkrw:rwp10-14
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