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Rethinking Optimal Exchange Rate Regimes With Frictional Labor Markets

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  • Campolmi, Alessia
  • Faia, Ester

Abstract

Currency fluctuations are an important determinant of labor market dynamics. Vice versa, relative labor costs affect real exchange rate dynamics. The optimal choice of exchange rate regimes cannot neglect this nexus. We assess such a choice using a two-country model with frictional labor markets. The monetary authority faces a tension between the classical insulating property of floating exchange rates and the destabilizing effects of currency fluctuations on (relative) job flows. Results show that the second motive is important: optimal monetary policy prescribes (some) response to the exchange rate. We also reexamine the conditions for optimal policy in a currency area whose members experience asymmetries in labor market institutions.

Suggested Citation

  • Campolmi, Alessia & Faia, Ester, 2015. "Rethinking Optimal Exchange Rate Regimes With Frictional Labor Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 19(5), pages 1116-1147, July.
    • Handle: RePEc:cup:macdyn:v:19:y:2015:i:05:p:1116-1147_00
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    Cited by:

    1. Juan J. Dolado & Gergő Motyovszki & Evi Pappa, 2021. "Monetary Policy and Inequality under Labor Market Frictions and Capital-Skill Complementarity," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(2), pages 292-332, April.
    2. Jianhua Feng & Chan Wang & Liyuan Wu & Dingsheng Zhang, 2021. "Unemployment, Trade Openness and Optimal Monetary Policy," Annals of Economics and Finance, Society for AEF, vol. 22(1), pages 231-253, May.
    3. Rhee, Hyuk Jae & Song, Jeongseok, 2018. "Labor market friction, nominal wage rigidities, and monetary policy in a small open economy," International Review of Economics & Finance, Elsevier, vol. 58(C), pages 140-158.
    4. Rhee, Hyuk Jae & Song, Jeongseok, 2020. "Wage rigidities and unemployment fluctuations in a small open economy," Economic Modelling, Elsevier, vol. 88(C), pages 244-262.
    5. Rhee, Hyuk-Jae & Song, Jeongseok, 2018. "Exchange Rate Pass-through, Nominal Wage Rigidities, and Monetary Policy in a Small Open Economy," East Asian Economic Review, Korea Institute for International Economic Policy, vol. 22(3), pages 337-370, September.
    6. Ester Faia, 2017. "Competitiveness, labor market institutions, and monetary policy," IZA World of Labor, Institute of Labor Economics (IZA), pages 383-383, August.

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