Faculty of Economics and Business Administration Publications Database

Optimal Monetary Policy Rules with Labour Market Frictions

Volume: 32
Number: 5
Pages: 1600 - 1621
Month: May
ISSN-Print: 0165-1889
Link External Source: Online Version
Year: 2008
Keywords: Optimal monetary policy rules; Matching frictions; Wage rigidity
Abstract: This paper studies optimal monetary policy rules in a framework with sticky prices, matching frictions and real wage rigidities. Optimal policy is given by a constrained Ramsey plan in which the monetary authority maximizes the agents’ welfare subject to the competitive economy relations and the assumed monetary policy rule. I find that the optimal rule should respond to unemployment alongside with inflation. This is so since models with matching frictions (unlike standard new Keynesian models) feature a congestion externality that makes unemployment inefficiently high. A strong response to inflation remains optimal while a response to output is always welfare detrimental.