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 featuring a frictional labor market with on-the-job search to quantitatively study the positive and normative implications of employer-to-employer (EE) transitions for macroeconomic outcomes and monetary policy. We find that EE dynamics played an important role in shaping inflation dynamics during the Great Recession and COVID-19 recoveries, with the former exhibiting subdued EE transitions and inflation despite both episodes sharing similar unemployment dynamics. Optimal monetary policy prescribes a strong positive response to EE fluctuations, which implies that central banks should distinguish between episodes with similar unemployment but different EE dynamics. We also show that accounting for market incompleteness significantly alters macroeconomic outcomes and optimal monetary policy prescriptions in response to changes in EE transitions.

Keywords: job mobility; monetary policy; heterogeneous agent New Keynesian (HANK) models; job search;

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

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