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A NOTE ON SIMPLE MONETARY POLICY RULES WITH LABOR MARKET AND FINANCIAL FRICTIONS

  • Šarūnas Girdėnas (a1)
Abstract

We consider a New-Keynesian model with financial and labor 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 one 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.

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Corresponding author
Address correspondence to: Sarunas Girdenas, Economics Department, Business School, University of Exeter, Streatham Court, Rennes Drive, EX4 4PU, Exeter, United Kingdom; e-mail: sg325@exeter.ac.uk.
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For advice and discussion, I would like to thank Tatiana Damjanovic, Dudley Cooke, Jack Rogers, Martin Ellison, Julian Neira, Keqing Liu, and all participants in the Macroeconomics Workshop at University of Warwick, the Search and Matching 2014 Conference and Exeter Economics Department seminars. I am also grateful to two anonymous referees for valuable comments and suggestions. I would like to acknowledge ESRC for financial support.

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Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
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