Policy Biases in a Model with Labor‐Market Frictions

Abstract We develop a model with labor‐market matching frictions that is subject to a range of shocks, including shocks to matching efficiency and bargaining power, and use the model to examine how monetary policy should respond to such shocks. We show that optimal monetary policy responds effectively to these shocks, producing economic outcomes that are close to the flex‐price equilibrium. Moreover, this effectiveness remains if monetary policy is conducted with discretion, indicating that time inconsistency and forward guidance are not central to the policy response.