Insider-Outsider Labor Markets, Hysteresis and Monetary Policy
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.
I am grateful for comments and suggestions to Sanjay Chugh, Juanjo Dolado, Yuriy Gorodnichenko, Nils Gottfries, Andy Levin, Silvana Tenreyro, Antonella Trigari, and two anonymous referees, as well as seminar and conference participants at the NBER Summer Institute, Oxford-NY Fed workshop, Banque de France, EUI-ADEMU, IAE-MacFinRobods Workshop, ECB-Fed International Research Forum on Monetary Policy, EABCN-University of Zurich Conference, Colegio Carlo Alberto, Riksbank, Norges Bank, IIES, Einaudi Institute and National Bank of Ukraine. Christian Hoynck, Cristina Manea, and Alain Schlaepfer provided excellent research assistance. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.