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Supply Shocks, Employment Gap, and Monetary Policy

Author

Listed:
  • Takushi Kurozumi

    (Bank of Japan)

  • Willem Van Zandweghe

    (Federal Reserve Bank of Cleveland)

Abstract

How should monetary policy respond to supply shocks in terms of inflation and employment stabilization? We introduce labor force entry and exit in an otherwise standard model with staggered price- and wage-setting to include employment in the model. A welfare-maximizing policy features wage growth stabilization with variation in the employment gap and inflation. Under staggered price- and wage-setting, the real wage adjustments to shocks entail a welfare cost, and variation in the employment gap contributes to reducing the welfare cost. Therefore, leaning against the employment gap induces substantial welfare losses for supply shocks compared to the welfare-maximizing policy.

Suggested Citation

  • Takushi Kurozumi & Willem Van Zandweghe, 2025. "Supply Shocks, Employment Gap, and Monetary Policy," Bank of Japan Working Paper Series 25-E-4, Bank of Japan.
    • Handle: RePEc:boj:bojwps:wp25e04
    as

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    File URL: https://www.boj.or.jp/en/research/wps_rev/wps_2025/data/wp25e04.pdf
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    References listed on IDEAS

    as
    1. Florin O. Bilbiie, 2021. "Monetary Neutrality with Sticky Prices and Free Entry," The Review of Economics and Statistics, MIT Press, vol. 103(3), pages 492-504, July.
    2. Christopher J. Erceg & Andrew T. Levin, 2014. "Labor Force Participation and Monetary Policy in the Wake of the Great Recession," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(S2), pages 3-49, October.
    3. Jushan Bai & Pierre Perron, 1998. "Estimating and Testing Linear Models with Multiple Structural Changes," Econometrica, Econometric Society, vol. 66(1), pages 47-78, January.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Labor force entry and exit; Extensive margin of labor; Staggered price- and wage-setting; Wage growth stabilization;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • J21 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Force and Employment, Size, and Structure

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