Monetary persistence and the labor market: A new perspective

Abstract

Abstract:It is common knowledge that the standard New Keynesian model is not able to generate a persistent response in output to temporary monetary shocks. We show that this shortcoming can be remedied in a simple and intuitively appealing way through the introduction of labor turnover costs (such as hiring and firing costs). Assuming that it is costly to hire and fire workers implies that the employment rate is slow to converge to its steady state value after a monetary shock. The after-effects of a shock continue to exert an effect on the labor market even long after the shock is over. The sluggishness of the labor market translates to the product market and thus the output effects of the monetary shock become more persistent. Under reasonable calibrations our model generates hump-shaped output responses. In addition, it is able to replicate the Beveridge curve relationship and a negative correlation between job creation and job destruction.

Macroeconomic volatilities and the labor market: First results from the euro experiment

“…These hiring and firing costs drive a wedge between the hiring decision and the firing decision. In their presence, the retention rate (i.e., 1 minus the firing rate) is always higher than the hiring rate (see Figure 2 in Lechthaler et al, 2010). Indeed, each incumbent worker generates the following profit:…”

“…Therefore, we choose a standard New Keynesian sticky price model (to capture the business cycle dimension) which is enhanced by a labor market with match suitability shocks and labor turnover costs. The model details are laid out in Lechthaler et al (2010) and Faia et al (2009). 8 5 The only papers analyzing the impact of labor market institutions on macroeconomic fluctuations in a monetary union are Abbritti and Mueller (2007) and Campolmi and Faia (2010).…”

“…However, they only consider level effects and not the second moments. The role of labor turnover costs in macroeconomic models has recently been pointed out by Lechthaler et al (2010) and Faia et al (2009). 7 We use shocks to the conduct of monetary policy (i.e., an aggregate demand shock) and productivity shocks (i.e., an aggregate supply shock).…”

“…Further details on the wage bargaining and the rest of the model can be found in Lechthaler et al (2010) and Faia et al (2009).…”

“…We proceed in two steps: First, we use a New Keynesian model that contains a new type of labor market model (see Lechthaler et al, 2010), which has so far not been used for this type of question, to analyze the effects of labor market institutions on macroeconomic volatilities, namely those of inflation and output. We use the second moments of the model economy to make theoretical predictions on the effects of firing costs (as they are known to be important in Europe 6 ) and unemployment benefit replacement rates (as they play an important role in the theoretical debate).…”