Optimal Monetary Policy Rules with Labour Market Frictions

This paper studies optimal monetary policy rules in a framework with sticky prices, matching

frictions and real wage rigidities. Optimal monetary policy is given by a constrained Ramsey

plan in which the monetary authority maximizes the agents’ welfare subject to the competitive

economy relations and the assumed monetary policy rule. I find that the optimal policy rule

should respond to unemployment alongside with inflation. This is so since models with matching

frictions (unlike standard New Keynesian models) feature a congestion externality that makes

unemployment inefficiently high. A strong response to inflation remains optimal while a response

to output is always welfare detrimental.