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Monetary Policy in the presence of Informal Labour Markets

  • Castillo, Paul

    (Banco Central de Reserva del Perú)

  • Montoro, Carlos

    (Banco Central de Reserva del Perú and Bank for International Settlements)

In this paper we analyse the effects of informal labour markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks. In doing so, we incorporate the informal sector in a modified New Keynesian model with labour market frictions as in the Diamond-Mortensen-Pissarides model. Our main results show that the informal economy generates a "buffer" effect that diminishes the pressure of demand shocks on aggregate wages and inflation. Finding that is consistent with the empirical literature on the e¤ects of informal labour markets in business cycle fluctuations. This result implies that in economies with large informal labour markets the interest rate channel of monetary policy is relatively weaker. Furthermore, the model produces cyclical flows from informal to formal employment consistent with the data.

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Paper provided by Banco Central de Reserva del Perú in its series Working Papers with number 2010-009.

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Date of creation: Jul 2010
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Handle: RePEc:rbp:wpaper:2010-009
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  1. Ravenna, Federico & Walsh, Carl E., 2008. "Vacancies, unemployment, and the Phillips curve," European Economic Review, Elsevier, vol. 52(8), pages 1494-1521, November.
  2. Tito Boeri & Pietro Garibaldi, 2006. "Shadow Sorting," Carlo Alberto Notebooks 10, Collegio Carlo Alberto.
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  3. Mark Gertler & Antonella Trigari, 2006. "Unemployment Fluctuations With Staggered Nash Wage Bargaining," NBER Working Papers 12498, National Bureau of Economic Research, Inc.
  4. Michael Woodford & Pierpaolo Benigno, 2004. "Inflation Stabilization and Welfare: The Case of a Distorted Steady State," 2004 Meeting Papers 481, Society for Economic Dynamics.
  5. Carlos Thomas, 2006. "Search and Matching Frictions and Optimal Monetary Policy," CEP Discussion Papers dp0743, Centre for Economic Performance, LSE.
  6. Mariano Bosch, 2006. "Job Creation and Job Destruction in the Presence of Informal Labour Markets," CEP Discussion Papers dp0761, Centre for Economic Performance, LSE.
  7. Antonella Trigari, 2009. "Equilibrium Unemployment, Job Flows, and Inflation Dynamics," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(1), pages 1-33, 02.
  8. Fugazza, Marco & Jacques, Jean-Francois, 2004. "Labor market institutions, taxation and the underground economy," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 395-418, January.
  9. Maurizio Bovi, 2007. "Shadow Employment and Labor Productivity Dynamics," LABOUR, CEIS, vol. 21(4-5), pages 735-761, December.
  10. Krause, M.U. & Lubik, T.A., 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Discussion Paper 2003-113, Tilburg University, Center for Economic Research.
  11. Kolm, Ann-Sofie & Larsen, Birthe, 2004. "Does tax evasion affect unemployment and educational choice?," Working Paper Series 2004:4, IFAU - Institute for Evaluation of Labour Market and Education Policy.
  12. Carillo, Maria Rosaria & Pugno, Maurizio, 2004. "The underground economy and underdevelopment," Economic Systems, Elsevier, vol. 28(3), pages 257-279, September.
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