In this paper we study optimal monetary policy in a model that integrates the modern theory of unemployment with a liquidity model of monetary transmission. Two policy environments are considered: period by period optimization (time consistency) and full commitment (Ramsey allocation). When the economy is subject to productivity shocks, the optimal policy is pro-cyclical. We also characterize the long-term properties of monetary policy and show that with commitment the optimal inflation rate is inversely related to the bargaining power of workers. Both results find empirical support in the data.