DP14886 Insider-Outsider Labor Markets, Hysteresis and Monetary Policy

Author(s): Jordi Galí
Publication Date: June 2020
Keyword(s): monetary policy tradeoffs, New Keynesian Model, Unemployment fluctuations, Wage Phillips Curve, Wage stickiness
JEL(s): E24, E31, E32
Programme Areas: Labour Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14886

I develop a version of the New Keynesian model with insider-outsider labor markets and hysteresis that can account for the high persistence of European unemployment. I study the implications of that environment for the design of monetary policy. The optimal policy calls for strong emphasis on (un)employment stabilization which a standard interest rate rule fails to deliver, with the gap between the two increasing in the degree of hysteresis. Two simple targetiing rules are shown to approximate well the optimal policy. The properties of the model and effects of different policies are analyzed through the lens of the labor wedge and its components.