Animal spirits and optimal monetary policy design in the presence of labour market frictions

Jeffrey Sheen, Ben Zhe Wang*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

2 Citations (Scopus)

Abstract

Using a New Keynesian DSGE model with labour market frictions, we compare outcomes for backward-looking animal spirits expectations with rational expectations after technology and demand shocks. For optimal monetary policy, major differences arise only for technology shocks, and discretionary policy performs better than commitment policy under animal spirits expectations. If Taylor rule parameters are chosen to best replicate optimal monetary policy outcomes, inflation targeting is only appropriate for technology shocks, particularly for large labour frictions, while targeting only economic activity is appropriate for demand shocks. Fault tolerance analysis shows high costs from failing to identify true animal spirits expectations and technology shocks.

Original languageEnglish
Pages (from-to)898-912
Number of pages15
JournalEconomic Modelling
Volume52
DOIs
Publication statusPublished - 1 Jan 2016

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