Abstract. Skill erosion during unemployment was of particular concern as unemployment duration increased in the Great Recession. I argue that it generates an externality in job creation: firms ignore how their hiring decisions affect the unemployment pool's skill composition, and hence the expected output produced by new hires. As a consequence, job creation is too low from a social point of view. But the extent to which it is too low varies over the cycle. This is because the externality's magnitude, which depends on the impact of job creation on the pool's skill composition, reduces when the share of unemployed workers who already have eroded skills increases.
This paper argues that human capital depreciation during unemployment generates an externality in job creation: firms ignore how their hiring decisions affect the skill composition of the future unemployment pool, and hence the output produced by new hires. As a consequence, job creation is too low from a social point view. But the extent to which it is too low varies over the cycle. The reason is that the increase in the expected productivity of a new hire from next period’s unemployment pool caused by hiring an additional worker today, depends on the pool’s composition, which varies over the cycle.
We reconsider the design of welfare-optimal monetary policy when financing frictions impair the supply of bank credit, and when the objectives set for monetary policy must be simple enough to be implementable and allow for effective accountability. We show that a flexible inflation targeting approach that places weight on stabilising inflation, a measure of resource utilisation, and a financial variable produces welfare benefits that are almost indistinguishable from fully-optimal Ramsey policy. The macro-financial trade-off in our estimated model of the euro area turns out to be modest, implying that the effects of financial frictions can be ameliorated at little cost in terms of inflation. A range of different financial objectives and policy preferences lead to similar conclusions.
Abstract. When workers are exposed to human capital depreciation during periods of unemployment, hiring affects the unemployment pool's composition in terms of skills, and hence the economy's production potential. Introducing human capital depreciation during unemployment into an otherwise standard New Keynesian model with search frictions in the labour market leads to the finding that the flexibleprice allocation is no longer constrained-efficient even when the standard Hosios (1990) condition holds. This is because it generates a composition externality in job creation: firms ignore how their hiring decisions affect the extent to which the unemployed workers' skills erode, and hence the output that can be produced by new matches. Consequently, it might be desirable from a social point of view for monetary policy to deviate from strict inflation targeting. Although optimal price inflation is no longer zero, strict inflation targeting is shown to stay close to the optimal policy.
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