Kiel Working Papers, Kiel Institute for World Economics
No 1534:
Labor Turnover Costs, Workers' Heterogeneity and Optimal Monetary Policy
Ester Faia, Wolfgang Lechthaler and Christian Merkl
Abstract: We study the design of optimal monetary policy in a New
Keynesian model with labor turnover costs in which wages are set according
to a right to manage bargaining where the firms’ counterpart is given by
currently employed workers. Our model captures well the salient features of
European labor market, as it leads to sclerotic dynamics of worker flows.
The coexistence of those types of labor market frictions alongside with
sticky prices gives rise to a non-trivial trade-off for the monetary
authority. In this framework, firms and current employees extract rents and
the policy maker finds it optimal to use state contingent inflation
taxes/subsidies to smooth those rents. Hence, in the optimal Ramsey plan,
inflation deviates from zero and the optimal volatility of inflation is an
increasing function of firing costs. The optimal rule should react to
employment alongside inflation
Keywords: optimal monetary policy, hiring and firing costs, labor market frictions, policy trade-off; (follow links to similar papers)
JEL-Codes: E52,; E24; (follow links to similar papers)
38 pages, July 2009
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