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Unemployment fluctuations, and optimal monetary policy in a small open economy

  • Hyuk Jae Rhee

    ()

    (Department of Economics, University of Windsor)

  • Jeongseok Song

    ()

    (Department of Economics,Chung-Ang University)

In this paper, we incorporate key ingredients of a small open economy into the New Keynesian model with unemployment of Gali (2011a,b) to discuss the design of the monetary policy. The main findings regarding the issue of monetary policy design can be summarized as threefold. First, the optimal policy is to seek to minimize variance of domestic price inflation, wage inflation, and the output gap if both domestic price and wage are sticky. Second, stabilizing unemployment rate is important to reduce the welfare loss incurred by both technology and labor supply shocks. Therefore, introducing the unemployment rate as an another argument into the Taylor-rule type interest rate rule will be welfare-enhancing. Last, controlling CPI inflation is the best when the policy is not allowed to respond to unemployment rate.

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File URL: http://web2.uwindsor.ca/economics/RePEc/wis/pdf/1309.pdf
File Function: First version, 2013
Download Restriction: no

Paper provided by University of Windsor, Department of Economics in its series Working Papers with number 1309.

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Length: 31 pages
Date of creation: 28 Aug 2013
Date of revision:
Handle: RePEc:wis:wpaper:1309
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  1. Faia, Ester, 2006. "Optimal monetary policy rules with labor market frictions," Working Paper Series 0698, European Central Bank.
  2. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  3. Jordi Gal� & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  4. Kuralbayeva, Karlygash, 2011. "Inflation persistence and exchange rate regime: Implications for dynamic adjustment to shocks in a small open economy," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 193-205, June.
  5. Olivier Blanchard & Jordi Gali, 2008. "Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployment," NBER Working Papers 13897, National Bureau of Economic Research, Inc.
  6. 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.
  7. Clarida, Richard & Galí, Jordi & Gertler, Mark, 2002. "A Simple Framework for International Monetary Policy Analysis," CEPR Discussion Papers 3355, C.E.P.R. Discussion Papers.
  8. Faia, Ester, 2007. "Ramsey monetary policy with labour market frictions," Working Paper Series 0707, European Central Bank.
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