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Learning About Monetary Policy Rules When Labor Market Search And Matching Frictions Matter

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Executive Summary

This paper examines implications of incorporating labor market search and matching frictions into a sticky price model for determinacy and E-stability of Rational Expectations Equilibrium (REE) under interest rate policy. When labor adjustment takes place solely at the extensive margin, forecast-based policy that meets the Taylor principle is likely to induce indeterminacy and E-instability, regardless of whether it is strictly or flexibly inflation targeting. When labor adjustment takes place at both the extensive and intensive margins, the strictly inflation-forecast targeting policy remains likely to induce indeterminacy, but it generates a unique E-stable fundamental REE as long as the Taylor principle is satisfied.

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