Optimal monetary policy rules with labor market frictions

Ester Faia

Journal of Economic Dynamics and Control, 2008, vol. 32, issue 5, 1600-1621

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.

Date: 2008
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Working Paper: Optimal monetary policy rules with labor market frictions (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:32:y:2008:i:5:p:1600-1621

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