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Sectoral labor mobility and optimal monetary policy

Published online by Cambridge University Press:  12 November 2021

Alessandro Cantelmo  and
Giovanni Melina
Alessandro Cantelmo*
Affiliation:
Banca d’Italia, Via Nazionale 91, Rome 00184, Italy
Giovanni Melina
Affiliation:
International Monetary Fund, 700 19th Street N.W., Washington, D.C. 20431, USA CESifo, Munich, Germany
*
Corresponding author. Email: alessandro.cantelmo@esterni.bancaditalia.it.
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Abstract

How should central banks optimally aggregate sectoral inflation rates in the presence of imperfect labor mobility across sectors? We study this issue in a two-sector New-Keynesian model and show that a lower degree of sectoral labor mobility, ceteris paribus, increases the optimal weight on inflation in a sector that would otherwise receive a lower weight. We analytically and numerically find that, with limited labor mobility, adjustment to asymmetric shocks cannot fully occur through the reallocation of labor, thus putting more pressure on wages, causing inefficient movements in relative prices, and creating scope for central bank’ s intervention. These findings challenge standard central banks’ practice of computing sectoral inflation weights based solely on sector size and unveil a significant role for the degree of sectoral labor mobility to play in the optimal computation. In an extended estimated model of the US economy, featuring customary frictions and shocks, the estimated inflation weights imply a decrease in welfare up to 10% relative to the case of optimal weights.

Keywords

Optimal Monetary PolicyDurable GoodsLabor Mobility
Type
Articles
Information
Macroeconomic Dynamics , Volume 27 , Issue 1 , January 2023 , pp. 1 - 26
Copyright
© The Author(s), 2021. Published by Cambridge University Press

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Footnotes

The views expressed in this paper are those of the authors and do not necessarily represent those of the International Monetary Fund or IMF policy or Banca d’Italia.

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