Sectoral Labor Mobility and Optimal Monetary Policy

56 Pages Posted: 28 Oct 2020

Multiple version iconThere are 2 versions of this paper

Date Written: 2020

Abstract

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 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.

Keywords: optimal monetary policy, durable goods, labor mobility

JEL Classification: E520, E580

Suggested Citation

Cantelmo, Alessandro and Melina, Giovanni, Sectoral Labor Mobility and Optimal Monetary Policy (2020). CESifo Working Paper No. 8638, Available at SSRN: https://ssrn.com/abstract=3720395 or http://dx.doi.org/10.2139/ssrn.3720395

Alessandro Cantelmo (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Giovanni Melina

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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