Optimal monetary policy in developing countries: The role of informality
In this paper, I analyze optimal monetary policy in developing countries whose labor markets are characterized by the presence of a large informal sector. I develop a closed economy model with nominal price and wage rigidities, search and matching frictions, and a dual labor market: a formal one cha...
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| Published in: | Journal of economic dynamics & control Vol. 155; p. 104724 |
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| Main Author: | |
| Format: | Journal Article |
| Language: | English |
| Published: |
Elsevier B.V
01-10-2023
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| Subjects: | |
| Online Access: | Get full text |
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| Summary: | In this paper, I analyze optimal monetary policy in developing countries whose labor markets are characterized by the presence of a large informal sector. I develop a closed economy model with nominal price and wage rigidities, search and matching frictions, and a dual labor market: a formal one characterized by matching frictions and nominal wage rigidities, and an informal one where wages are fully flexible. Under this framework, a trade-off between price and wage inflation emerges. I find that informality increases the response of price and wage inflation to aggregate productivity shocks. As a result, the presence of an informal sector increases the inefficient fluctuations of labor market variables, such as unemployment, labor market tightness, and formal hiring rate. I find that optimal policy with informality features significant deviations from price stability in response to aggregate productivity shocks. |
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| ISSN: | 0165-1889 1879-1743 |
| DOI: | 10.1016/j.jedc.2023.104724 |