CAPACITY AND ASYMMETRIES IN MONETARY POLICY
15
Notice that when υ -÷y, equation (3.1) reduces to the following expression:
(3.5) Lf = g
In the opposite case, when all firms have idle resources, and thus underutilize their
productive capacities, the proportion of firms π (¾) = 1 and the real wage rate
given in (2.16) becomes,
(3.6)
Wt
Pt
Λ.∖f
(1 + 0
Along the short-run labor demand curve there is a negative relationship between
the demand elasticity of sales, π (¾), and employment, Lt. Also, a downwards shift
along the short-run labor demand curve increases the mark-up, since the proportion
of firms at full capacity is larger and so is the spill-over effect from constrained to
unconstrained firms. The implications of a monetary policy shock on the response
of the labor market are shown in Chart 2. An unanticipated expansionary monetary
policy shock leads to a reduction in the short-term nominal interest rate through
the liquidity effect. This implies that the maximum feasible real wage rate increases.
The short-run labor demand curve intersects now the vertical axis at a higher value.
As a result, the equilibrium in the labor market implies a rise in employment. The
number of firms producing at full capacity also increases. This fact produces a
positive spillover into the remaining firms that have idle resources. The market
power of these firms naturally rises and hence does the mark-up in the economy.
The capacity utilization rate also moves in the same direction. It is important
to notice that the effects of the monetary disturbance are going to depend crucially
on the state of the economy at the time of the shock, with the state determined by
the capacity utilization rate. Hence, further reductions in the nominal interest rate
achieved through expansionary policies will have less impact on employment and,
as will be shown later, a higher effect on prices.
An important shortcoming of the previous intuition about the short-run effects
of a monetary shock is that it is based on an exogenous movement in the interest
rate. However, the equilibrium rate of interest is determined jointly with other
variables in the model such as employment and output. The results below aim at
providing a general equilibrium insight into this issue.
Proposition 1. The impact effect of an unanticipated monetary policy shock on
employment is positive,
_ d∖o⅛Lt _ dLt a⅛
x't d log xt dxt Lt
as is the instantaneous correlation with output
= d IogTt = dTt a⅛ 0
x't d log xt dxt yt
Proof. Taking the ratio of the loan market-clearing condition, WtLt = Dt + Xt to
the cash equation, Eq. (2.31), one obtains
3.7) Γt
Wt Lt _ Dt + Xt
Pt Ct - Mt + Xt
Notice that since Dt < Mt and both variables are predetermined relative to Xt,
the response of Γt to an innovation in the rate of growth of money xt ≡ Xt/Mt is