Labor Market Frictions and Optimal Monetary Policy

13/01/2013 |  Binyamini Alon
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Monetary Policy and Inflation

We study the properties of optimal monetary policy in an environment of nominal wage rigidity and unemployment. We show that nominal wage rigidity increases the sacrifice ratio, and therefore reduces the effectiveness of sacrificing employment in order to stabilize inflation. It follows that in response to higher nominal wage rigidity, it is optimal to allow for smaller fluctuations of unemployment at the expense of larger inflation fluctuations.

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