Research

This paper provides empirical evidence that low-skilled unemployment rates are significantly more responsive to monetary policy shocks than high-skilled unemployment rates. Using local projections with identified monetary policy shocks, I estimate that a 0.25 percentage point decrease in the federal funds rate leads to a more pronounced and persistent reduction in the low-skilled unemployment rate relative to its high-skilled counterpart. Motivated by these empirical findings, I construct a tractable New Keynesian DSGE model featuring asymmetric search and matching (S&M) frictions to account for skill-specific differences in labor market behavior. The model integrates implementable Taylor-type monetary policy rules that respond not only to inflation but also to skill-specific unemployment rates. The welfare analysis shows that the optimal policy involves jointly targeting inflation and skill-specific unemployment, with a stronger emphasis on low-skilled unemployment due to its greater sensitivity to policy changes. This approach achieves higher welfare outcomes and reduces labor market volatility across skill groups compared to standard Taylor rules that focus solely on inflation and output stabilization.

As part of its framework review in 2020, the Federal Reserve (Fed) announced its intent to switch to average in ation targeting (AIT) rather than in ation targeting (IT). We estimate interest rate reaction functions pre- and post-2020. Pre-2020, Fed policy is well characterized by a conventional Taylor-type rule that reacts to period inflation. Post-2020, in contrast, the Fed appears to have reacted strongly to average inflation and not to period inflation, in line with the stated goals of the 2020 framework review. In the context of a textbook New Keynesian model, we show that AIT is similar to interest rate smoothing. In the face of large demand shocks, AIT results in a delayed policy response and higher, more persistent inflation. This pattern is roughly consistent with macroeconomic performance in the US post-2020.

This paper examines the effect of monetary policy on the extensive margin of the production sector when the borrowing cost of the firm differs by its productivity. Consistent with the literature and the empirical findings, (i) monetary policy stimulates the entry of the firms not only through the trade-off between increased demand and increased cost, but also directly through reducing the borrowing cost. However, in the current calibration of the model, (ii) monetary policy might offset the initial increase in output through the demand channel by directly attracting less efficient firms. In contrast, a model without size dependent interest rate exhibits a pronounced output response and moderate inflation sensitivity, lacking the economic stabilization conferred by differentiated borrowing costs. Moreover, a model without size dependent interest rate and firm entry/exit mechanisms displays amplified output and inflation responses, indicative of a standard New Keynesian approach that abstracts from firm dynamics. Inclusion of size dependent borrowing costs and dynamic firm behavior in our model dampens these responses, suggesting a stabilizing effect on the economy and highlighting the transitory nature of policy impacts, which are absent in the standard framework.