Incorporating Labour Market Frictions into an Optimising-Based Monetary Policy Model

This paper examines the effects of introducing a non Walrasian labour market into the "New Neoclassical Synthesis'' framework. A dynamic stochastic general equilibrium model is formulated, solved, and calibrated in order to evaluate its ability to replicate the main features of the Euro area economy. This framework allows us to study the effects of labour market rigidities, nominal rigidities, and other frictions to give account of the impact of monetary policy, technology, public spending, and preference shocks. Our simulations show that: (i) real rigidities complement but do not supplant nominal rigidities, (ii) the Beveridge and Phillips relations are reproduced, (iii) hours worked are too sensitive an adjustment variable, and (iv) the real wage dynamics is still procyclical.