Optimal Monetary Policy with Skill Heterogeneity and Wage Rigidity

Abstract

Labor market indicators such as unemployment rates and labor force participation show a significant amount of heterogeneity across demographic groups, which is often not incorporated in monetary policy analysis. In this paper, I build a dynamic stochastic general equilibrium model with skill heterogeneity in the U.S. labor market. Low-skilled workers have a higher elasticity of labor supply and labor demand, resulting in a flatter wage Phillips curve for low-skilled workers. A welfare improving optimal monetary policy with skill differentials can be implemented by a simple interest rate rule with unemployment rates for high and low-skill workers. Welfare improvement is twice that of a naive policy, where the central bank makes low-skill workers significantly better-off but high-skill workers are slightly worse-off.