Comparing Optimal Monetary Policy Rules, Does Wage Inflation Matters?

Abstract

The aim of this paper is to determine the optimal monetary policy for the Tunisian economy by comparing different targeting rules in terms of welfare loss. Our approach is conducted through simulated scenarios from a small open economy DSGE model, with frictions in the labor market. We are motivated by the fact that the Tunisian economy suffers from inflation, unemployment and a continuous depreciation of its currency which put pressure on production costs. In addition, with underdeveloped financial market attention is given to exchange rate volatility. Recent literature focuses on wage inflation to reduce production costs and unemployment caused by terms of trade fluctuations rather than reacting to the exchange rate. Our main result is the superiority of the wage inflation rule in reducing welfare losses.

Keywords

• wage inflation
• unemployment
• optimal monetary policy
• rules
• dsge
• tunisia.