Optimal Monetary Policy in the Presence of Human Capital Depreciation During Unemployment

Abstract

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.

The Cost of Human Capital Depreciation During Unemployment

“…Pavoni (2009), Shimer andWerning (2006), Pavoni and Violante (2007), and Spinnewijn (2010)). Laureys (2014) analyses the implications of human capital depreciation during unemployment for optimal monetary policy.…”

Slow Recoveries and Unemployment Traps: Monetary Policy in a Time of Hysteresis*

“…Related literature A small number of recent papers study hysteresis and monetary policy in the presence of nominal frictions. Closest to our work are Laureys (2014), who studies optimal monetary policy when skill depreciates during unemployment spells, 9 and Galí (2016), who studies optimal policy in a New Keynesian model with insider-outside labor markets drawing on the earlier work of Blanchard and Summers (1986). These papers argue that monetary policy should deviate from strict inflation targeting and put more emphasis on unemployment stabilization.…”

The Cost of Human Capital Depreciation During Unemployment

“…Pavoni (2009), Shimer and Werning (2006), Pavoni and Violante (2007), and Spinnewijn (2010)). Laureys (2014) analyses the implications of human capital depreciation during unemployment for optimal monetary policy.…”