Uninsured Unemployment Risk and Optimal Monetary Policy

Edouard Challe

No 9, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: I study optimal monetary policy in a New Keynesian economy wherein house- holds precautionary-save against uninsured, endogenous unemployment risk. In this economy greater unemployment risk raises desired savings, causing aggregate demand to fall and ul- timately feed back to greater unemployment risk. I show this deationary feedback loop to be constrained-ine¢ cient and to call for an accommodative monetary policy response: after a contractionary aggregate shock the policy rate should be kept signi cantly lower and for longer than in the perfect-insurance benchmark. For example, the usual prescription obtained under perfect insurance of a hike in the policy rate in the face of a bad supply (i.e., productivity or cost-push) shock is easily overturned. If implemented, the optimal policy e¤ectively breaks the deflationary feedback loop and takes the dynamics of the imperfect-insurance economy close to that of the perfect-insurance benchmark.

Date: 2018
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ias, nep-mac and nep-mon
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Citations: View citations in EconPapers (3)

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Working Paper: Uninsured Unemployment Risk and Optimal Monetary Policy (2017)
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