Aren't Labor Markets Important for Monetary Policy?

Abstract

I study the role of labor markets in the transmission of persistent monetary policy shocks. Using a New Keynesian model with labor market frictions I find that labor market conditions can affect the outcomes of persistent monetary policy shocks suggesting a trade-off between inflation and output growth: restricted labor market access leads to higher inflation response with smaller effects on output. I further show that empirical evidence from a model with time-varying parameters and stochastic volatility estimated on U.S. data is consistent with the predictions of the New Keynesian model.