A Note on Simple Monetary Policy Rules with Labour Market and Financial Frictions

Paper number: 16/01

Paper date: March 18, 2016

Year: 2016

Paper Category: Discussion Paper

Authors

Sarunas Girdenas

Abstract

We consider a New-Keynesian model with financial and labour market frictions where firms borrowing is limited by the enforcement constraint. The wage is set in a bargaining process where the firm's shareholder and worker share the production surplus. As debt service is considered to be a part of production costs, firms borrow to reduce the surplus which allows to lower the wage. We study the model's response to financial shock under two Taylor-type interest rate rules: first one responds to inflation and borrowing, second - to inflation and unemployment. We have found that the second rule delivers better policy in terms of the welfare measure. Additionally, we show that the feedback on unemployment in this rule depends on the extent of workers' bargaining power.

Keywords: Labour Market Frictions, Financial Frictions, Optimal Monetary Policy, Monetary Policy Rules

JEL classi…cation: E52, E43, E24

A Note on Simple Monetary Policy Rules with Labour Market and Financial Frictions A Note on Simple Monetary Policy Rules with Labour Market and Financial Frictions