Employment, wages and optimal monetary policy

Abstract

We study optimal monetary policy when the policymaker is uncertain whether the cyclical properties of employment and wages are determined by sticky nominal wages or by search and matching frictions in the labor market. Unless the policymaker is almost certain about the search and matching model being the true data-generating process, the policymaker chooses to stabilize wage inflation at the expense of price inflation, the policy resembling the optimal policy in the sticky wage model, regardless of the true model. This finding reflects the greater sensitivity of welfare losses in the sticky wage model to deviations from the model-specific optimal policy.