A Study in Optimal Monetary Policy, Inflation and Capital Accumulation

This thesis analyses the effect of optimal monetary policy in economies with imperfect labour and financial markets. It also studies how the interaction between structural characteristics and inflation can affect the economic growth. Chapters 2 and 3 build on the literature on the New Keynesian model and assess quantitatively the optimal conduct of monetary policy. Chapter 2 analyses the optimal monetary policy in a currency union with involuntary unemployment and real wage rigidity by focusing on the role of labour market heterogeneity. Results show that in the presence of country-specific and aggregate productivity shocks, under the monetary policy regimes of optimal commitment or discretion, the welfare losses in the currency union increase monotonically with the degree of labour market heterogeneity. Chapter 3 quantifies the welfare gains from the central bank using the discount window as a complementary instrument of monetary policy in an economy with a frictional financial market. Previous literature has characterised discount window as redundant. The novelty of chapter 3 is that it constructs a general-equilibrium model which is used to quantify the effect of discount window lending in households’ welfare. In contrast with the previous literature, chapter 3 provides an argument in support of the view that discount window can be an effective instrument of monetary policy. Chapter 4 studies the role of social status that is associated with investment projects in economic growth. By merging a growth model with a credit market framework, chapter 4 analyses the interaction between social status and inflation and the implications on the economy’s long-term prospects. Results show that inflation is disruptive for capital accumulation. However, the latter is enhanced from the presence of social status concerns. Chapter 4 concludes that the role of structural characteristics can be important in determining an economy’s long-term performance.