What is the role of higher wage flexibility of new hires for optimal monetary policy?

Higher wage flexibility of new hires is introduced as an extension of the baseline model in Gali (2010), combining the New Keynesian monetary analysis framework with labor market frictions. It was shown that the possibility of higher wage flexibility of new hires has an implication forcrucial labor market decisions made by households and firms,as well as on the form of social welfare loss function that is used to evaluate alternative monetary policies. Obtained extension allows one to conduct normative monetary policy analysis for different scenarios of degrees of higher wage flexibility fornew hires. Optimal monetary policy in the presence of higher wage flexibility of new hires is characterized by a higher incentive to make inflation more stable and by less incentive to facilitate adjustment of real wages in response to real shocks. Thus, the possibility of higher wage flexibility of new hires provides support toward more strict inflation targeting in the presence of nominal price and wage rigidities