Two-sector New Keynesian Model Research Articles

Public expenditure multipliers and informality

This paper investigates the role of informality in affecting the magnitude of the public expenditure multiplier in a panel of 142 countries, using the local projections method. We find a strong negative relationship between the degree of informality and the size of the multiplier. This result holds irrespective of the level of economic development and institutional quality and is robust to additional country characteristics such as trade and financial openness and exchange rate regime. In a two-sector New-Keynesian model, we rationalize this result by showing that fiscal shocks raise the relative price of official goods, thereby shifting demand towards the informal sector. This reallocation effect increases with the level of informality, because a larger informal sector is associated with a stronger appreciation of relative prices in response to fiscal shocks, and thus reduces the multiplier.

Sectoral labor mobility and optimal monetary policy

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.

Sectoral Labor Mobility and Optimal Monetary Policy

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 banks 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 U.S. economy, featuring customary frictions and shocks, the estimated inflation weights imply a decrease in welfare up to 10 percent relative to the case of optimal weights.

Optimal Monetary Policy Under Sectoral Interconnections

We explore the role of intersectoral factor demand linkages for the design of optimal monetary policy. A two-sector new-Keynesian model is developed in which the sectors are connected through factor demand linkages. Moreover, they differ in price stickiness. We obtain two important results: first, the presence of factor demand linkages causes amplification effects in resource mis-allocation and, hence, the concern for price stability becomes relatively more important. Second, the optimal price index is not the same as the aggregate price index, although it does not directly depend on the factor demand linkages themselves. Furthermore, based on the micro-founded loss function we derive a policy rule that implements the optimal allocation.

Sectoral Labor Mobility and Optimal Monetary Policy

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 banks 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 U.S. economy, featuring customary frictions and shocks, the estimated inflation weights imply a decrease in welfare up to 10 percent relative to the case of optimal weights.

Monetary Policy and the Relative Price of Durable Goods

In a VAR model of the US, the response of the relative price of durables to a monetary contraction is either flat or mildly positive. It significantly falls only if narrowly defined as the ratio between new house and nondurables prices. These findings survive three identification strategies and across subsamples. Then, they are rationalized via the estimation of a two-sector New-Keynesian model. Here, the degree of overall durables price stickiness is not dramatically lower than that of nondurables. Such macroeconometric results are close to recent microeconometric evidence. Moreover, they suggest that monetary policy is not very distortive of sectoral allocations.

Sectoral Labor Mobility and Optimal Monetary Policy

In an estimated two-sector New-Keynesian model with durable and nondurable goods, an inverse relationship between sectoral labor mobility and the optimal weight the central bank should attach to durables inflation arises. The combination of nominal wage stickiness and limited labor mobility leads to a nonzero optimal weight for durables inflation even if durables prices were fully flexible. These results survive alternative calibrations and interestrate rules and point toward a non-negligible role of sectoral labor mobility for the conduct of monetary policy.