Unemployment and Optimal Monetary Policy (in Korean)

Insu Kim () and Myung-Soo Yie ()
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Insu Kim: University of California, Riverside
Myung-Soo Yie: Financial & Monetary Economics Team, Economic Research Institute, The Bank of Korea

No 2014-36, Working Papers from Economic Research Institute, Bank of Korea

Abstract: This paper studies the role of unemployment as a feedback variable in monetary policy interest rate rules. While labor market variables are perceived to be important ingredients to explain business cycle fluctuations, many new Keynesian dynamic stochastic general equilibrium (DSGE) model literatures based on Korean economy consider output for the real sector variable in the feedback rule. We build a DSGE model with sticky prices and wages and unemployment, estimate the model using Korean data, and compare welfare losses between the rule responding to unemployment and the rule responding to output. We find that the rule responding to unemployment growth is more welfare improving than other rules. It is because unemployment growth contains information on not only output gap, but also price inflation and wage inflation which are components of welfare loss function. Therefore, responding to unemployment growth mitigates inefficiencies from sticky prices and wages at the same time. This result holds with and without uncertainty in output gap and unemployment gap. While, in case of certainty, the rule responding to output gap is more welfare improving than the rule responding to output growth, the result is reversed in case of uncertainty because the rule responding to uncertain output gap measure misleadingly increases fluctuations of other variables. These results imply that, when central banks practice monetary policy, unemployment can be used as a useful feedback variable together with inflation and output variables.

Keywords: Optimal Monetary Policy; Unemployment; Habit Formation; DSGE (search for similar items in EconPapers)
JEL-codes: E12 E24 E52 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2014-12-18
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