Labor Market Shocks and Monetary Policy

RePEc Short ID: pbi318
ORCID iD: 0000-0001-7323-1932

Birinci, Serdar; Karahan, Fatih; Mercan, Yusuf; See, Kurt

doi:10.20955/wp.2022.016

Working Paper Revision

Labor Market Shocks and Monetary Policy

Abstract: We develop a heterogeneous-agent New Keynesian model with a frictional labor market and on-the-job search to study how employer-to-employer (EE) transitions affect macroeconomic outcomes and monetary policy. We find that EE dynamics significantly shaped inflation during the Great Recession and COVID-19 recoveries. Despite similar unemployment paths, the former experienced weaker EE transitions and lower inflation. Optimal monetary policy prescribes a strong positive response to EE fluctuations, implying central banks should distinguish between episodes with similar unemployment but different EE patterns. We show that accounting for market incompleteness alters macroeconomic outcomes and optimal monetary policy prescriptions upon changes in EE transitions.

JEL Classification: E12; E24; E52; J31; J62; J64;

https://doi.org/10.20955/wp.2022.016