Faculty of Economics and Business Administration Publications Database

Ramsey Monetary Policy with Labour Market Frictions

Volume: 56
Number: 4
Pages: 570 - 581
Month: May
ISSN-Print: 0304-3932
Link External Source: Online Version
Year: 2009
Keywords: Optimal monetary policy; Matching frictions; Congestion externality
Abstract: Traditional New Keynesian models prescribe that optimal monetary policy should aim at price stability. In the absence of a labor market frictions, the monetary authority faces no unemployment/inflation trade-off. The design of optimal monetary policy is analyzed here for a framework with sticky prices and matching frictions in the labor market. Optimal policy features deviations from price stability in response to both productivity and government expenditure shocks. When the Hosios [1990. On the efficiency of matching and related models of search and unemployment. Review of Economic Studies 57 (2), 279–298] condition is not met, search externalities make the flexible price allocation unfeasible. Optimal deviations from price stability increase with workers’ bargaining power, as firms incentives to post vacancies fall and unemployment fluctuates above the Pareto efficient one.