Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 259: Labor-Market Frictions and Optimal Inflation

Mikael Carlsson () and Andreas Westermark ()
Additional contact information
Mikael Carlsson: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Andreas Westermark: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: In central theories of monetary non-neutrality the Ramsey optimal inflation rate varies between the negative of the real interest rate and zero. This paper explores how the interaction of nominal wage and search and matching frictions affect the policy prescription. We show that adding the combination of such frictions to the canonical monetary model can generate an optimal inflation rate that is significantly positive. Specifically, for a standard U.S. calibration, we find a Ramsey optimal inflation rate of 1.11 percent per year.

Keywords: Optimal Monetary Policy; Inflation; Labor-market Distortions

JEL-codes: E52; H21; J60

35 pages, March 1, 2012

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