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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.

Suggested Citation

  • Hyuk Jae Rhee & Jeongseok Song, 2013. "Unemployment fluctuations, and optimal monetary policy in a small open economy," Working Papers 1309, University of Windsor, Department of Economics.
  • Handle: RePEc:wis:wpaper:1309

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    References listed on IDEAS

    1. Olivier Blanchard & Jordi Galí, 2010. "Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 1-30, April.
    2. Faia, Ester, 2008. "Optimal monetary policy rules with labor market frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1600-1621, May.
    3. Clarida, Richard & Gali, Jordi & Gertler, Mark, 2002. "A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 879-904, July.
    4. Faia, Ester, 2009. "Ramsey monetary policy with labor market frictions," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 570-581, May.
    5. 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.
    6. Jordi Galí & 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.
    7. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
    8. 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.
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    More about this item


    Unemployment; Monetary policy; Small open economy.;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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