Optimal monetary policy in a dual labor market: the role of informality

M. Gomez ()

No 19124, Documentos de trabajo - Alianza EFI from Alianza EFI

Abstract: In this paper I analyze the optimal monetary policy in emerging countries whose labor markets are mainly characterized by the presence of a large informal sector. I develop a closed economy model with nominal price and wage rigidities, search and matchingfrictions and a dual labor market. A formal one characterized by matching frictions, and nominal wage rigidities, and an informal one where wages are fully flexible. Under this framework, a trade-off between price and wage inflation emerges. I find that informality increases the response of price and wage inflation to aggregate productivity shocks. As a result, the presence of an informal sector increases the inefficient fluctuations of the labor market variables, such as unemployment, labor market tightness, and formal hiring rate. I derive the second-order approximation to the welfare of the representative agent, and then I characterize the optimal monetary policy for standard calibration of the model. I find that optimal policy with informality features significant deviations from price stability in response to aggregate productivity shocks.

Keywords: Informality; Monetary policy; Nominal wage and price rigidities; Inflation targeting. (search for similar items in EconPapers)
JEL-codes: E12 E26 E52 E61 (search for similar items in EconPapers)
Pages: 52
Date: 2020-11-03
New Economics Papers: this item is included in nep-cba, nep-iue, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:col:000561:019124

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