Macro-labour linkages are being studied on the basis of an unemployment flow model with a macro-economic closure, using a reduced-form New Keynesian Phillips Curve. The presentation gives an overview of the main model mechanisms and estimation resutls. In a policy section, the working of tighter employment protection and more rigid wage developments are being presented.
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Labour dynamics in macro models
1. Labour dynamics in macro models
Shock transmission through labour markets
Ekkehard Ernst1
1
Employment Trends Unit
International Labour Organization
Geneva
ernste@ilo.org
http://ekkehard.ernst.free.fr
IMF
Apr 18th, 2012
E. Ernst (ILO) ILO Modelling Washington, 2012 1 / 27
2. Understanding growth and employment The traditional approach
The ILO Global Employment Trends approach
GET is based on a tight employment-growth link
Okun’s law as methodological background
Allows regional and country-specific employment projections
Useful for imputation of missing data
Employment by different labour market segments
Metholodolgy can be applied at the level of individual labour
market segments
Allows to differentiate for employment by:
Age
Gender
Sector
Status (self-employment, informal employment)
E. Ernst (ILO) ILO Modelling Washington, 2012 2 / 27
3. Understanding growth and employment A new method
Considering labour dynamics more closely
Unemployment is the result of labour flow dynamics
In the current crisis both unemployment in- and outflows explain
unemployment dynamics
Different factors help explain their movements ⇒analysis
necessary for precise policy recommendations
Characteristic patterns of both flow types over the business cycle
0.024
0.4
0.022
0.3
Job destruction rate
Job creation rate
0.020
0.2
0.018
0.1
0.016
0.0
1970 1980 1990 2000 2010
Job creation rate Job destruction rate
Note: No data available for Argentina, China, India, Indonesia and Saudi Arabia.
Shaded areas correspond to global recessions
Source: GET Labour flows model
E. Ernst (ILO) ILO Modelling Washington, 2012 3 / 27
4. Understanding growth and employment A new method
Labour flows and the business cycle
Okun’s law approach insufficient
In- and outflows are mutually dependent via employment stocks
Strong cyclical variations of coefficients make the traditional
approach impractical
Calls for integrating flows in a (small) macro model
Elasticitiy of job creation rates Elasticitiy of job destruction rates
(wrt. to GDP growth, time−varying) (wrt. to GDP growth, time−varying)
0.35
0.01
Pre−crisis peak (2008)
0.00
0.30
Coefficient estimate
Coefficient estimate
−0.01
0.25
−0.02
0.20
−0.03
Great recession (2009)
0.15
1970 1980 1990 2000 2010 1970 1980 1990 2000 2010
Confidence interval Time−varying estimate Confidence interval Time−varying estimate
E. Ernst (ILO) ILO Modelling Washington, 2012 4 / 27
5. Understanding growth and employment Overview of today’s talk
Overview
1 Modelling unemployment flows
Research strategy
What drives unemployment dynamics?
2 A macro “wrapper”
Modelling and estimation strategy
A finance-augmented double Phillips curve
3 Estimation and model dynamics
Data and methodology
Estimating the labour flow macro-model
Model dynamics under shocks
4 Shock transmission under different policy settings
5 Concluding remarks
E. Ernst (ILO) ILO Modelling Washington, 2012 5 / 27
6. Modelling unemployment flows Research strategy
Aiming at a fully estimated model
In the tradition of macro-econometric models
All parameters are estimated; no calibration
All variables are based on observables
Instrumentation of expectation variables
Including policy reaction functions
Taylor rule for monetary policy
Government spending rule for fiscal policy
Monetary-fiscal interactions via public debt
E. Ernst (ILO) ILO Modelling Washington, 2012 6 / 27
7. Modelling unemployment flows Research strategy
Model ideas I
Flow model of the labour market
Empirical formulation of standard matching model
Full and separate account of unemployment in- and
outflows
See, e.g., Carlsson et al. (2006)
Financial frictions model
Real-share prices affect investment and long-term
interest rates (e.g., Phelps, 1994)
Yield curve with sticky long-term interest rates
Productivity shocks as medium-term drivers
E. Ernst (ILO) ILO Modelling Washington, 2012 7 / 27
8. Modelling unemployment flows Research strategy
Model ideas II
Wage-price dynamics
Double Phillips curve (e.g. Flaschel et al. 1997; Erceg
et al. 2000):
Reduced-form wage bargaining curve
Hybrid Phillips curve
Labour market policies interact with structural shocks
Use reduced-form strategies to model structural policies
Employment protection
Wage policies/bargaining institutions
Policy identification through parameter changes
E. Ernst (ILO) ILO Modelling Washington, 2012 8 / 27
9. Modelling unemployment flows What drives unemployment dynamics?
An overview of the model flows I
Decomposing unemployment dynamics into...
Ut = Lt − ETt = INt − OUTt
...Labour force growth and...
Lt = α3 + β31 Lt −1 + β32 ut −1 + β33 Taxt
...Employment growth (i.e. the net effect of job creation and destruction)
ETt = JobCreationt − JobDestructiont
E. Ernst (ILO) ILO Modelling Washington, 2012 9 / 27
10. Modelling unemployment flows What drives unemployment dynamics?
An overview of the model flows II
Job creation
JobCreationt = β11 ETt −1 + β12 wt + β13 ADt + β14 rt + β15 Invt +
β16 JobCreationt −1
Job destruction
JobDestructiont = β21 TFPt + β22 rt + β23 REERt + β24 ADt + β25 wt +
β26 JobDestructiont −1
Wage determination:
wt = α4 + β41 Kt + β42 CBt + β43 ut −1 + β44 Taxt
E. Ernst (ILO) ILO Modelling Washington, 2012 10 / 27
11. Modelling unemployment flows What drives unemployment dynamics?
Putting the pieces together
Substituting the flow equations:
OUTt = JobCreationt
INt = JobDestructiont + ∆Lt −1
Hence:
OUTt = β11 OUTt −1 + β12 XtJobCreation + β14 ETt −1
INt = β21 INt −1 + β22 XtJobDestruction + β24 Lt −1
E. Ernst (ILO) ILO Modelling Washington, 2012 11 / 27
12. A macro “wrapper” Modelling and estimation strategy
Modelling methodology I
Step-by-step estimation
Step 1: Identify base-line equations
Macro variables to affect unemployment flows
Reduced-form panel estimates
System-GMM used to control for endogeneity
Results published in Ernst (2011)
Step 2: Identify relevant fiscal interactions
Labour flow model generically refers to aggregate demand
Possibility to set up specific fiscal interactions such as:
Wage- vs. Non-wage public consumption
Direct vs. indirect taxation
Labour market programmes (ALMP, UB)
Results published in Ernst and Rani (2011)
E. Ernst (ILO) ILO Modelling Washington, 2012 12 / 27
13. A macro “wrapper” Modelling and estimation strategy
Modelling methodology II
Step 3: Estimate macro model
Introduce macro-economic closure: Modified Euler equation
Introduce endogenous policy rules
Estimate using GMM
Step 4: Simulate model and reform scenarios
Model simulation using Dynare
Reform scenarios through parametric change
Analysis of shock transmission:
Financial shocks (share prices)
Productivity shocks
Analyse impact on unemployment dynamics
E. Ernst (ILO) ILO Modelling Washington, 2012 13 / 27
14. A macro “wrapper” A finance-augmented double Phillips curve
Financial frictions and labour flows
Share price dynamics
Financial accelerator effect due to variations in real share
prices, Ft
Gross-fixed capital formation also depends on public
investment and real long-term interest rates:
Kt = Kt −1 + Ft −1 + GtI−1 + LPt −1 + rtL 1
−
Yield curve
Wedge between long- and short-term interest rates
Short-term rates determined by household expectations and
policy interventions
Long-term rates with persistence determined by:
Share prices
Net government lending
E. Ernst (ILO) ILO Modelling Washington, 2012 14 / 27
15. A macro “wrapper” A finance-augmented double Phillips curve
A double Phillips curve
Price inflation
πt = πt −1 + E πt+1 + REERt −1 + Gapt −1
Wage inflation
wt = wt −1 + ETt −1 + πt −1 + E πt+1 + TFPt −1
Output gap dynamics
Gapt = wt + OUTt −1 + INt −1 + GovConst −1
E. Ernst (ILO) ILO Modelling Washington, 2012 15 / 27
16. Estimation and model dynamics Data and methodology
A word on the data and methodology
Unemployment flows come from Elsby et al. (2008)
Constructed on the basis of information regarding unemployment duration at
different duration lengths
Complemented by similar information for more years and other countries to
improve coverage
Extended coverage possible using imputation methods with broadly similar
results
Information on share price dynamics is based on OECD share price index
(OECD Main Economic Indicators) deflated by CPI
Macro indicators come from the OECD Economic Outlook database
Fixed effects have been accounted for through de-meaning:
dXit = Xit − Xi · + X··
E. Ernst (ILO) ILO Modelling Washington, 2012 16 / 27
19. Estimation and model dynamics Estimating the labour flow macro-model
Estimation results: Fiscal block
GovConst−1 ∆ETt−1
(11) GovConst 0.973*** 0.025*
(0.025) (0.015)
GovInvt−1 ∆ETt−1
(12) GovInvt 0.959*** 0.028***
(0.042) (0.007)
OUTt−1 INt−1
(13) Taxt 0.010*** 0.003
(0.001) (0.003)
GovConst GovInvt Taxt
(14) NLGQt -88.626*** -122.280*** 106.385***
(4.530) (9.230) (3.129)
E. Ernst (ILO) ILO Modelling Washington, 2012 19 / 27
20. Estimation and model dynamics Model dynamics under shocks
Unemployment and productivity shocks
Reduction in total factor productivity leads to...
Productivity growth Gross fixed capital formation
0 0.5
−0.2
0
−0.4
−0.5
−0.6
−0.8 −1
10 20 30 40 50 10 20 30 40 50
Unemployment Output gap
20 0
15
−20
10
−40
5
0 −60
10 20 30 40 50 10 20 30 40 50
E. Ernst (ILO) ILO Modelling Washington, 2012 20 / 27
21. Estimation and model dynamics Model dynamics under shocks
Transmission of financial shocks
Adverse shock to real share prices and its effect on the real economy
Unemployment Output gap
8 0
−2
6
−4
4
−6
2
−8
0 −10
10 20 30 40 50 10 20 30 40 50
Gross fixed capital formation Real wage growth
0 0
−1
−0.01
−2
−0.02
−3
−4 −0.03
10 20 30 40 50 10 20 30 40 50
E. Ernst (ILO) ILO Modelling Washington, 2012 21 / 27
22. Shock transmission under different policy settings
Policy change scenarios
How to model shifts in structural policies?
Structural model with reduced-form elements
Allows changes in certain parameters to be identified with policy changes:
Shock transmission on unemployment flows
Reactivity of wages to productivity shocks
Employment protection legislation...
...affect the level of unemployment flows, but this has no effect in our
linearized model
...also affect the elasticity of flows wrt shocks
Dynamic effects depend on the transmission margin that is affected most
Question: Why do some countries with high EPL seem to have suffered less
from financial crisis?
Wage policies/collective bargaining institutions
Minimum wages affect wage level⇒Level effects only
Collective bargaining affects elasticity of wages wrt productivity,
unemployment and inflation
E. Ernst (ILO) ILO Modelling Washington, 2012 22 / 27
23. Shock transmission under different policy settings
Dynamic effects of changes in EPL I
Higher EPL =⇒ weaker reaction of unemployment to adverse financial shocks
6.0
5.0
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1 3 5 7 9 94 74 54 34 14 93 73 53 33 13 92 72 52 32 12 91 71 51 31 11
1.0-
secirp erahs laer ot kcohs retfa sraeY
Baseline Lower reactivity of flows to shocks after increasing EPL
E. Ernst (ILO) ILO Modelling Washington, 2012 23 / 27
24. Shock transmission under different policy settings
Dynamic effects of changes in EPL II
Decomposing shifts in unemployment dynamics: Biggest effect stems from the
interest rate channel
10
5
Composition of changes in unemployment dynamics
0
1 6 11 16 21 26 31 36 41 46
Years after shock to real share prices
-5
-10
-15
-20
-25
-30
Interest rate transmission Output gap transmission Wage growth transmission
Investment transmission Total effect of reforms
E. Ernst (ILO) ILO Modelling Washington, 2012 24 / 27
25. Shock transmission under different policy settings
Changes in the wage pass-through
Changes in the reactivity of wages have substantial effects on the dynamics of
unemployment
0.015
0.01
Unemployment reaction to productivity shock
0.005
(Deviation from steady state)
0
1 6 11 16 21 26 31 36 41 46
kcohs ytivitcudorp esrevda retfa sraeY
-0.005
-0.01
-0.015
Baseline Lower reactivity of wages to employment conditions
Higher real wage rigidity Lower sensitivity of wages to inflation
E. Ernst (ILO) ILO Modelling Washington, 2012 25 / 27
26. Concluding remarks
Lessons learned and outlook
What have we learned so far?
Linear structural model allows full estimation of all parameters
Pass-through play important role for labour flows and unemployment
Allows detailed analysis of transmission mechanisms
Next steps
Labour flow data available for 60+ countries
Develop open economy and global model, based on estimation of regional
blocks
Country-specific pass-through effects rather than fixed effect
Allow for more direct policy interactions (include policy variables in the model
set-up)
Need more precise (empirical) information on flow elasticities wrt structural
policies
E. Ernst (ILO) ILO Modelling Washington, 2012 26 / 27
27. Bibliography
Bibliography
Carlsson, M.; Eriksson, S.; Gottfries, N. 2006. Testing Theories of Job
Creation: Does Supply Create Its Own Demand? Discussion Paper, No. 2024
(Bonn: Institute for the Study of Labor (IZA)).
Erceg, C. J.; Henderson, D. W.; Levin, A. T. 2000. "Optimal monetary
policy with staggered wage and price contracts", Journal of Monetary
Economics, Vol. 46, No. 2, pp. 281-313.
Ernst, E. 2011. Determinants of unemployment flows. Labour market
institutions and macroeconomic policies. Discussion paper, No. 209 (Geneva:
International Institute for Labour Studies), available at:
http://www.ilo.org/public/english/bureau/inst/download/dp209_2011.pdf
Ernst, E.; Rani, U. 2011. “Understanding unemployment flows”, Oxford
Review of Economic Policy, Volume 27, No. 2, pp. 268–294.
Flaschel, P.; Franke, R.; Semmler, W. 1995. Dynamic macroeconomics.
Instability, fluctuations, and growth in monetary economies. (Cambridge,
MA.: MIT Press).
Phelps, E. 1994. Structural Slumps. (Cambridge, MA.: Harvard University
Press).
E. Ernst (ILO) ILO Modelling Washington, 2012 27 / 27