Comments on Search and Matching Frictions and Optimal Monetary Policy

The synthesis between new Keynesian models and the non-Walrasian theory of unemployment moves a step forward in replicating business cycle facts concerning the labor market and provides a useful benchmark for policy analyses. One consequence of this is that researchers also question how and whether prescriptions of optimal monetary policy can change into this new environment. This is exactly the question that motivates Carlos Thomas paper. This paper builds a new Keynesian model with matching frictions and staggered Nash bargained wages (obtained by introducing a Calvo, 1983, structure for nominal wage stickiness into an otherwise standard Nash bargaining process) and uses this model economy to analyze the design of optimal monetary policy. The latter is implemented through a micro-founded linear quadratic approach a’ la Woodford (2003) which consists in deriving a quadratic loss function by taking second order approximation

of agents’ utility. This loss function, in combination with the linearized constraints describing the economy’s competitive equilibrium, is used to implement the design of optimal monetary policy. Thomas’ paper confirms the optimality of price stability in the presence of matching frictions and flexible wages, while deviations from zero inflation are optimal in presence of wage rigidity. Deviations from zero inflation occur since real wage rigidity distorts incentives for efficient job creation and since wage dispersion induces inefficient dispersion in hiring rates. Those two distortions are summarized in the gap between the allocation arising under efficient Nash bargaining and the allocation associated with wage rigidity. The paper also stresses how the introduction of wage rigidity into the matching framework helps to reconcile the Barro (1977) critique which states that for ongoing employment relations we would expect employers and employees to neutralize the distortionary effects of wage stickiness. The combination of matching frictions and Nash staggered wages allows to do so as private efficiency of employment relationships is preserved.