The Role of Labor Markets for Euro Area Monetary Policy

FRB of Philadelphia Working Paper No. 09-01

58 Pages Posted: 5 Feb 2009

See all articles by Kai Philipp Christoffel

Kai Philipp Christoffel

European Central Bank (ECB)

Keith Kuester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Tobias Linzert

European Central Bank (ECB); IZA Institute of Labor Economics

Multiple version iconThere are 2 versions of this paper

Date Written: January 7, 2009

Abstract

In this paper, we explore the role of labor markets for monetary policy in the euro area in a New Keynesian model in which labor markets are characterized by search and matching frictions. We first investigate to which extent a more flexible labor market would alter the business cycle behavior and the transmission of monetary policy. We find that while a lower degree of wage rigidity makes monetary policy more effective, i.e. a monetary policy shock transmits faster onto inflation, the importance of other labor market rigidities for the transmission of shocks is rather limited. Second, having estimated the model by Bayesian techniques we analyze to which extent labor market shocks, such as disturbances in the vacancy posting process, shocks to the separation rate and variations in bargaining power are important determinants of business cycle fluctuations. Our results point primarily towards disturbances in the bargaining process as a significant contributor to inflation and output fluctuations. In sum, the paper supports current central bank practice which appears to put considerable effort into monitoring euro area wage dynamics and which appears to treat some of the other labor market information as less important for monetary policy.

Keywords: Labor Market, wage rigidity, bargaining, Bayesian estimation

JEL Classification: E32, E52, J64, C11

Suggested Citation

Christoffel, Kai Philipp and Kuester, Keith and Linzert, Tobias, The Role of Labor Markets for Euro Area Monetary Policy (January 7, 2009). FRB of Philadelphia Working Paper No. 09-01, Available at SSRN: https://ssrn.com/abstract=1337778 or http://dx.doi.org/10.2139/ssrn.1337778

Kai Philipp Christoffel (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Keith Kuester

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Tobias Linzert

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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