Macroeconomics of the Labor Market - CESifo

Macroeconomics of the Labor Market By Christian Merkl

CES-Lecture 3: Monetary and Fiscal Policies under Frictional Labor Markets Munich, August 2013

Monetary and Fiscal Policy

• Monetary policy: small scale New Keynesian model (NKM) – Empirical problems – Unappealing/unrealistic normative issues • Fiscal policy: Real Business Cycle model (RBC) or NKM – Size of fiscal multipliers – Non-traditional crisis measures – Optimal tax behavior 2

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Agenda

• Monetary Policy – Show most important building block of NKM – Empirical shortcomings – Labor markets: • Positive issues • Normative issue

• Fiscal policy – Issues – Virtues of labor market analysis 3


The New Keynesian Model

• Key ingredients: – RBC model (see lecture 2 for a labor centric RBC model without capital) – Monopolistic competition – Price rigidities (e.g. Calvo, Taylor, Rotemberg)

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Stylized Model Structure

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Wholesale and Retail Sector CES production technology: Rotemberg adjustment costs:

s.t.:

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Problem 1: No endogenous persistence Reaction of the standard small scale loglinearized three equation model to a one-off interest rate shock:

No (endogenous) model persistence at all!

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Problem 2: The Divine Coincidence

• The standard small-scale new Keynesian framework implies no trade-off between output and inflation stabilization. • Stabilizing the welfare relevant output is equivalent to stabilizing inflation. • Blanchard and Galí (2007) write that the divine coincidence is at odds with central bankers’ perception. • The introduction of real rigidities may break the divine coincidence. 8


Monetary Policy and the Labor Market Channel 1: Wage Rigidities • A labor market with flows offers the possibility to solve these problems. • The bilateral monopoly and the wage bargaining in search and matching model offers the natural laboratory for modeling wage rigidities (no Barro critique). • Wage rigidities may make marginal costs more persistent and thus may make inflation more persistent • In addition: breaking the divine coincidence 9


Standard Framework: Wage Rigidities and Inflation

 1   1    r  t  Et t 1  mct 

More persistent real marginal costs generate more persistent inflation! BUT: Barro Critique

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Search and Matching Framework: Wage Rigidities and Inflation • However, Krause and Lubik (2007) show that there is countervailing effect in the search and matching framework: – Rigid wages  labor market tightness varies more over the cycle – Thus, the costs of hiring a worker is more cyclical with rigid wages (i.e. increases more in a boom)!

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Search and Matching Framework: Wage Rigidities and Inflation

Baseline: money growth shock

Source: Krause/Lubik (2007)

12 Rigid wages: money growth shock


Monetary Policy and the Labor Market Channel 2: Firing Costs • Firing costs can only be integrated into a labor market with flows. • Firing costs depress labor market flows and thereby increase the persistence of employment and output.  Positive analysis: Lechthaler, Merkl, Snower (2010) • Firing costs generate an important externality!  Normative analysis: Faia, Lechthaler, Merkl (2013) 13


Digression: Labor Selection • Every searching employee can contact one employer per discrete time period. • Suitability of employers and employees is determined in an interview (drawing an idiosyncratic iid cost shock). • Applicants with low idiosyncratic cost shocks obtain a job offer. • Existing worker-firm pairs also draw from idiosyncratic shock distribution. • The labor market is driven by selection/deselection. 14


Digression: Why Labor Selection instead of Search and Matching? • Advantages – No black box – Analysis of labor market institutions more explicit – No amplification puzzle

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Graphical Illustration Cumulative distribution

1 Firing Rate

Job Finding Rate

0 Important Retention rate > job finding rate 16


Labor Selection: Equations

• Hiring threshold

with Thus: • Firing threshold 17


Illustration: Reaction to an Autocorrelated Interest Rate Shock

Source: Lechthaler et al. (2010)

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The Role of Labor Turnover Costs

Source: Lechthaler et al. (2010)

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Price Stability versus Optimal Ramsey Policy: Reaction to Productivity Shock

Source: Faia et al. (2013)

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Externality • More recruiting today reduces the pool of future applicants (not taken into account by atomistic firms). • Entrants have lower idiosyncratic costs on average  composition effect! • Externality is not internalized by standard wage bargaining mechanisms. • Optimal monetary policy reduces the externality. • Mechanism: Employment fluctuations

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Optimal Inflation Volatility and Firing Costs


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Fiscal Policy

• Add fiscal sector to the model (e.g. income taxes, value added taxes and profit taxes and government spending). • Advantages of having a labor market: – Reconsider size of fiscal multiplier – Reconsider adjustment path – Analyze non-standard measures (e.g. labor market subsidies or short-time work).

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Fiscal Policy: Evaluation of Different Measures


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Optimal Fiscal Policy: Tax Smoothing? • Frictionless labor market model calls for smooth labor taxation over the cycle. • Arseneau and Chugh (2013) show that this result may not hold any more under search and matching labor markets (Hagedorn/Manovskii calibration)  tax volatility may induce efficient (smaller) fluctuations of labor markets. • This result is linked to the result that the search and matching model can only generate amplification under inefficient wage formation (social planner solution is not decentralized). 25


Conclusion • Monetary policy: – Wage rigidities: break divine coincidence, but do not necessarily generate more inflation persistence. – Firing costs: break divine coincidence and generate more output persistence. • Fiscal policy: – Reaction to traditional government spending changes. – Analysis of non-standard measures. – Optimal taxation different!  The labor market matters for macroeconomic policies!

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References • Arseneau, David and Chugh, Sanjay (2012). “Tax Smoothing in Frictional Labor Markets.” Journal of Political Economy, Vol. 120, 926985. • Blanchard, Olivier, and Galí, Jordi (2007): "Real Wage Rigidities and the New Keynesian Model." Journal of Money, Credit, and Banking, Vol. 39, No. 1, Supplement, 35-65. • Faia, Ester, Lechthaler, Wolfgang, and Merkl, Christian (2013): “Labor Selection, Turnover Costs and Optimal Monetary Policy.” Journal of Money, Credit, and Banking, forthcoming. • Faia, Ester, Lechthaler, Wolfgang, and Merkl, Christian (2013): “Fiscal Stimulus and the Labor Market Policies in Europe.” Journal of Economic Dynamics and Control, Vol. 37 (3), 2013, 483-499. • Krause, Michael, Lubik, Thomas (2007). “The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions.” Journal of Monetary Economics, Vol. 54 (3), 706–727. • Lechthaler, Wolfgang, Merkl, Christian, and Snower, Dennis (2010): “Monetary Persistence and the Labor Market: A New Perspective.” für VWL Journal of Economic Dynamics and Control, Vol. 34 (5), 2010, 968-983. 27 Lehrstuhl Makroökonomik