The Welfare Consequences of Monetary Policy and the Role of the Labor Market: a Tax Interpretation
We explore the distortions in business cycle models arising from inefficiencies in price setting and in the search process matching firms to unemployed workers, and the implications of these distortions for monetary policy. To this end, we characterize the tax instruments that would implement the first best equilibrium allocations and then examine the trade-offs faced by monetary policy when these tax instruments are unavailable. Our findings are that the welfare cost of search inefficiency can be large, but the incentive for policy to deviate from the inefficient flexible-price allocation is in general small. Sizable welfare gains are available if the steady state of the economy is inefficient, and these gains do not depend on the existence of an inefficient dispersion of wages. Finally, the gains from deviating from price stability are larger in economies with more volatile labor flows, as in the U.S.
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- Carlos Thomas, 2006.
"Search and matching frictions and optimal monetary policy,"
LSE Research Online Documents on Economics
19782, London School of Economics and Political Science, LSE Library.
- Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
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- Faia, Ester, 2008.
"Optimal monetary policy rules with labor market frictions,"
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Elsevier, vol. 32(5), pages 1600-1621, May.
- Faia, Ester, 2006. "Optimal monetary policy rules with labor market frictions," Working Paper Series 0698, European Central Bank.
- Arseneau, David M. & Chugh, Sanjay K., 2008.
"Optimal fiscal and monetary policy with costly wage bargaining,"
Journal of Monetary Economics,
Elsevier, vol. 55(8), pages 1401-1414, November.
- David M. Arseneau & Sanjay K. Chugh, 2007. "Optimal fiscal and monetary policy with costly wage bargaining," International Finance Discussion Papers 893, Board of Governors of the Federal Reserve System (U.S.).
- Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
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