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WP 2011/4 – Alessia Campolmi – Stefano Gnocchi: Labor Market Participation, Unemployment and Monetary Policy

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In the present paper we examine how the introduction of endogenous participation in an otherwise standard DSGE model with matching frictions and nominal rigidities affects business cycle dynamics and monetary policy. The contribution of the paper is threefold: first, we show that the model provides a good fit for employment and unemployment volatility, as well as participation volatility and its correlation with output for US data. Second, we show that in such a model, and contrary to a model with exogenous participation, a monetary authority that becomes more aggressive in fighting inflation decreases the volatility of employment and unemployment. Finally, we show the role of search costs in shaping those results.

JEL: E24, E32, E52.

Keywords: matching frictions, endogenous participation, monetary policy.

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