Monetary Policy in the presence of Informal Labour Markets

Paul Castillo and Carlos Montoro

No 2010-009, Working Papers from Banco Central de Reserva del Perú

Abstract: In this paper we analyse the effects of informal labour markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks. In doing so, we incorporate the informal sector in a modified New Keynesian model with labour market frictions as in the Diamond-Mortensen-Pissarides model. Our main results show that the informal economy generates a "buffer" effect that diminishes the pressure of demand shocks on aggregate wages and inflation. Finding that is consistent with the empirical literature on the e¤ects of informal labour markets in business cycle fluctuations. This result implies that in economies with large informal labour markets the interest rate channel of monetary policy is relatively weaker. Furthermore, the model produces cyclical flows from informal to formal employment consistent with the data.

Keywords: Monetary Policy; New Keynesian Model; Informal Economy; Labour Market Frictions. (search for similar items in EconPapers)
JEL-codes: E32 E50 J64 O17 (search for similar items in EconPapers)
Date: 2010-07
New Economics Papers: this item is included in nep-cba, nep-dge, nep-lab, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (27)

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Persistent link: https://EconPapers.repec.org/RePEc:rbp:wpaper:2010-009

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