A predominant share of employment in EMDEs is in the informal sector. In India (2019–2020), approximately 72% of total employment was informal — 22% casual and 50% self-employed. This study examines how labor market informality affects inflation stabilization and monetary policy setting using a medium-scale NK-DSGE model with segmented labor markets and search and matching frictions, calibrated for India.

Results show that increased formality improves policy efficiency. A contractionary monetary policy shock leads to a decline in both formal and informal employment, indicating that monetary policy transmission also operates through informal labor markets. The paper highlights how heterogeneous labor structures shape monetary policy outcomes in emerging and developing economies.