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Monetary Policy in the presence of Informal Labour Markets

Author

Listed:
  • Castillo, Paul

    (Banco Central de Reserva del Perú)

  • Montoro, Carlos

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

Abstract

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.

Suggested Citation

  • Castillo, Paul & Montoro, Carlos, 2010. "Monetary Policy in the presence of Informal Labour Markets," Working Papers 2010-009, Banco Central de Reserva del Perú.
    • Handle: RePEc:rbp:wpaper:2010-009
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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