Search And Matching Frictions And Optimal Monetary Policy

I analyze optimal monetary policy in an economy with search and matching frictions in the labor market and staggered nominal wage and price contracts. In this framework, as opposed to the standard New Keynesian model, preset nominal wages need not have any effect on existing employment relationships. However, staggered bargaining of nominal wages distorts aggregate job creation and creates inefficient dispersion in hiring rates across firms. Targeting zero inflation (the optimal policy in the standard New Keynesian model) only magnifies these distortions. The optimal policy allows for non-zero inflation in response to real shocks, so as to reduce the rigidity of real wages. Quantitatively, the case against price stability as the sole goal of monetary policy turns out to be important.

I introduce unemployment into the New Keynesian model by assuming search and matching frictions in the labor market, and analyze the implications for optimal monetary policy. In this framework, firms can adjust both their number of workers and hours per worker. Social efficiency requires eliminating inflation, closing the output gap (equivalently, setting hours at their efficient level), as well as preventing deviations of employment from its efficient path. I show that, provided the economy's steady state is efficient, if wages follow the Nash bargaining rule the central bank can achieve the efficient allocation. If wages are rigid, then the central bank faces a trade-off among its stabilization objectives. Following e.g. a negative productivity shock, the central bank must temporarily concede an increase in inflation, a drop in the output gap and a fall in employment below its efficient path.

Froyen and Guender have provided a thorough and careful analysis of optimal monetary policy over most of the range of theoretical models that have been used in modern macroeconomics. By providing a comprehensive and clear comparative framework they will help the student of monetary policy understand why there have been conflicting views of what policy makers should do. Central Banking In Optimal Monetary Policy Under Uncertainty, academicians and economists Richard T. Froyen and Alfred V. Guender have collaborated on presenting an informed and informative survey of optimal monetary policy literature arising during the 1970s and 1980s as a ground work for understanding current market and other economic influences on such germane issues as discretion versus commitment, target versus instrument rules, and the delegation of policy making authority within the private and public sectors. With meticulous attention to scholarship and objectivity. . . Optimal Monetary Policy Under Uncertainty is a thoughtful and thought-provoking body of work that is very strongly recommended for professional, academic, corporate and governmental economic reference collections and supplemental reading lists. Midwest Book Review Recently there has been a resurgence of interest in the study of optimal monetary policy under uncertainty. This book provides a thorough survey of the literature that has resulted from this renewed interest. The authors ground recent contributions on the science of monetary policy in the literature of the 1970s, which viewed optimal monetary policy as primarily a question of the best use of information, and studies in the 1980s that gave primacy to time inconsistency problems. This broad focus leads to a better understanding of current issues such as discretion versus commitment, target versus instrument rules, and the merits of delegation of policy authority. Casting a wide net, the authors survey the recent literature on the New Keynesian approach to optimal monetary policy in the context of the earlier literature. They emphasize the relationship between policy decisions and the information set available to the policymaker, a central focus of the earlier literature, obscured in much recent work. Optimal policy questions are considered in open as well as closed economy models and the often confusing terminology in the literature is sorted and clarified. Questions are considered within easily analysed models and the authors clearly show why these models lead to different (or equivalent) policy conclusions. Recent policy issues such as desirability of inflation targeting and the relative merits of target versus instrument rules are covered in detail. Economists in academia and in policymaking organizations who want to learn about recent developments in the area of optimal monetary policy, as well as graduate and advanced undergraduate students in macroeconomic and monetary economics, will find this volume a clear and thorough examination of the topic.

The financial crisis proved strikingly that the structure of the financial system and financial frictions play a crucial role for the effectiveness of monetary policy but also for system risk. Policymakers have overlooked financial intermediation and financial stability. Shadow banks and especially in the euro area the interbank market play a crucial role in propagating financial turmoil. This dissertation addresses these circumstances and contributes to the research on the optimal design of macroeconomic policy with a particular focus on monetary unions with heterogeneous financial sectors. As the consequences for monetary policy are at the heart of this thesis, I use state-of-the-art dynamic stochastic general equilibrium models and implement financial intermediation and frictions to analyze the transmission channels and interactions of (optimal) fiscal, monetary, macroprudential as well as unconventional monetary policy.

Labor Markets and Business Cycles integrates search and matching theory with the neoclassical growth model to better understand labor market outcomes. Robert Shimer shows analytically and quantitatively that rigid wages are important for explaining the volatile behavior of the unemployment rate in business cycles. The book focuses on the labor wedge that arises when the marginal rate of substitution between consumption and leisure does not equal the marginal product of labor. According to competitive models of the labor market, the labor wedge should be constant and equal to the labor income tax rate. But in U.S. data, the wedge is strongly countercyclical, making it seem as if recessions are periods when workers are dissuaded from working and firms are dissuaded from hiring because of an increase in the labor income tax rate. When job searches are time consuming and wages are flexible, search frictions--the cost of a job search--act like labor adjustment costs, further exacerbating inconsistencies between the competitive model and data. The book shows that wage rigidities can reconcile the search model with the data, providing a quantitatively more accurate depiction of labor markets, consumption, and investment dynamics. Developing detailed search and matching models, Labor Markets and Business Cycles will be the main reference for those interested in the intersection of labor market dynamics and business cycle research.

We study optimal monetary policy in an environment in which firms' pricing and production decisions are subject to informational frictions. Our framework accommodates multiple formalizations of these frictions, including dispersed private information, sticky information, and certain forms of inattention. An appropriate notion of constrained efficiency is analyzed alongside the Ramsey policy problem. Similar to the New-Keynesian paradigm, efficiency obtains with a subsidy that removes the monopoly distortion and a monetary policy that replicates flexible-price allocations. Nevertheless, "divine coincidence" breaks down and full price stability is no more optimal. Rather, the optimal policy is to "lean against the wind", that is, to target a negative correlation between the price level and real economic activity. Keywords: Business Cycles, Dispersed Information, Stick Information, Rational Inattention, Optimal Policy, Price Stability. JEL Classifications: E32, E52, D61, D83.

"The optimal currency literature has stressed the importance of labor mobility as a precondition for the success of monetary unions. But only a few studies formally link labor mobility to macroeconomic adjustment and policy. In this paper, we study macroeconomic dynamics and optimal monetary policy in an economy with cyclical labor flows across two distinct regions that share trade links and a common monetary framework. In our New Keynesian dynamic, stochastic, general-equilibrium model calibrated to the United States, migration flows are driven by fluctuations in the relative labor market performance across the monetary union. While labor mobility can be an additional channel for cross-regional spillovers as well as a regional shock absorber, we find that a mobile labor force closes the efficiency gaps in the labor market and thus lessens the trade-off between inflation and labor market stabilization. As migration flows are generally inefficient, however, region-specific disturbances introduce additional trade-offs with regional labor market conditions. Putting some weight on stabilizing fluctuations in the labor market enhances welfare when monetary policy follows a simple rule"--Abstract, page ii.