The Welfare Consequences of Monetary Policy and the Role of the Labor Market: a Tax Interpretation

Federico Ravenna and Carl Walsh

No 10-01, Cahiers de recherche from HEC Montréal, Institut d'économie appliquée

Abstract: We explore the distortions in business cycle models arising from inefficiencies in price setting and in the search process matching firms to unemployed workers, and the implications of these distortions for monetary policy. To this end, we characterize the tax instruments that would implement the first best equilibrium allocations and then examine the trade-offs faced by monetary policy when these tax instruments are unavailable. Our findings are that the welfare cost of search inefficiency can be large, but the incentive for policy to deviate from the inefficient flexible-price allocation is in general small. Sizable welfare gains are available if the steady state of the economy is inefficient, and these gains do not depend on the existence of an inefficient dispersion of wages. Finally, the gains from deviating from price stability are larger in economies with more volatile labor flows, as in the U.S.

JEL-codes: E52 E58 J64 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2010-07
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Working Paper: The Welfare Consequences of Monetary Policy and the Role of the Labor Market: a Tax Interpretation (2010)
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