Optimal monetary policy in the open economy with labor market frictions

Cholwoo Kim
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Cholwoo Kim: Department of Economics, University of Warwick

The Warwick Economics Research Paper Series (TWERPS) from University of Warwick, Department of Economics

Abstract: This paper examines Ramsey-type optimal monetary policy in an open economy with a two-country dynamic general equilibrium model where search and matching frictions exist in labor markets along with the limited participation in the financial markets. Monetary policy affects the decision of firms in labor markets because firms finance their wage bills with loans from domestic financial intermediaries in advance. There are two main results associated with optimal monetary policy. The long-term optimal nominal interest rate could be zero suggesting negative optimal inflation rate in the long run because the terms of trade effect on consumption could be weaken by search frictions. As a result of Ramsey optimal monetary policy, dynamics of business cycles in both countries show similar patterns in response to a productivity shock and, in turn, higher cross-country correlations of real variables.

Keywords: labor market frictions; search and matching; working capital; optimal monetary policy JEL Codes: E24; E52; F41 (search for similar items in EconPapers)
Date: 2025
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:wrk:warwec:1539

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