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Sectoral Labor Adjustment and Monetary Policy in a Small Open Economy

Kang Shi ()

No 302011, Working Papers from Hong Kong Institute for Monetary Research

Abstract: This paper studies the welfare implications of sectoral labor adjustment cost in a two-sector small open economy model with sticky prices. We find that, when the economy faces external shocks, if monetary policy can stabilize the real economy, then sectoral labor market adjustment cost will lead to welfare loss. However, if monetary policy such as fixed exchange rates cannot stabilize real variables, then some degree of labor market friction will improve welfare instead and the gain will be significant. As a result, the welfare gap between flexible exchange rates and fixed exchange rates decreases with sectoral labor market friction. This is because the friction can offset some of the nominal rigidity and become a substitute for monetary policy to stabilize the real economy.

Keywords: Labor Adjustment Cost; Exchange Rate Policy; Two-Sector Model; Welfare (search for similar items in EconPapers)
JEL-codes: F3 F4 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2011-09
New Economics Papers: this item is included in nep-cba, nep-mon and nep-opm
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Citations: View citations in EconPapers (9) Track citations by RSS feed

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