Output gap, monetary policy trade-offs, and financial frictions

This paper investigates how the presence of pervasive financial frictions and large shocks changes optimal monetary policy prescriptions estimated dynamics in a New Keynesian model. We find that factors affect only to some extent. A nominal stabilization (with particular focus on targeting wage inflation) is still policy, although central bank now unable fully stabilize economic activity around its potential level. In contrast, crucially size shape output gap relative importance different driving fluctuations, with absorbing explanatory power from labor supply shocks.