Optimal monetary policy in the presence of human capital depreciation during unemployment

Lien Laureys

No 514, Bank of England working papers from Bank of England

Abstract: When workers are exposed to human capital depreciation during periods of unemployment, hiring affects the unemployment pool’s composition in terms of skills, and hence the economy’s production potential. Introducing human capital depreciation during unemployment into an otherwise standard New Keynesian model with search frictions in the labour market leads to the finding that the flexible-price allocation is no longer constrained-efficient even when the standard Hosios condition holds. This is because it generates a composition externality in job creation: firms ignore how their hiring decisions affect the extent to which the unemployed workers’ skills erode, and hence the output that can be produced by new matches. Consequently, it might be desirable from a social point of view for monetary policy to deviate from strict inflation targeting. But quantitative analysis shows that although optimal price inflation is no longer zero, strict inflation targeting stays close to the optimal policy.

Keywords: skill erosion; monetary policy; unemployment (search for similar items in EconPapers)
JEL-codes: E24 E52 J64 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2014-10-24
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 (14)

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Related works:
Working Paper: Optimal monetary policy in the presence of human capital depreciation during unemployment (2015)
Working Paper: Optimal Monetary Policy in the Presence of Human Capital Depreciation during Unemployment (2014)
Working Paper: Optimal monetary policy in the presence of human capital depreciation during unemployment (2014)
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