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Optimal Monetary Policy with Durable Consumption Goods and Factor Demand Linkages

  • Petrella, Ivan
  • Santoro, Emiliano

This paper deals with the implications of factor demand linkages for monetary policy design. We consider a dynamic general equilibrium model with two sectors that produce durable and non-durable goods, respectively. Part of the output of each sector serves as a production input in both sectors, in accordance with a realistic input-output structure. Strategic complementarities induced by factor demand linkages significantly alter the transmission of exogenous shocks and amplify the loss of social welfare under optimal monetary policy, compared to what is observed in standard two-sector models. The distinction between value added and gross output that naturally arises in this context is of key importance to explore the welfare properties of the model economy. A flexible inflation targeting regime is close to optimal only if the central bank balances inflation and value added variability. Otherwise, targeting gross output variability entails a substantial increase in the loss of welfare.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 21321.

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Date of creation: 11 Mar 2010
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Handle: RePEc:pra:mprapa:21321
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