Labor-Market Frictions and Optimal Inflation

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 Classification: E52, H21, J60

Suggested Citation: Suggested Citation

Carlsson, Mikael and Westermark, Andreas, Labor-Market Frictions and Optimal Inflation (March 2012). Riksbank Research Paper Series No. 90, Sveriges Riksbank Working Paper Series No. 259, Available at SSRN: https://ssrn.com/abstract=2092516 or http://dx.doi.org/10.2139/ssrn.2092516