Labour dynamics in macro models

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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. 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, 2012E. Ernst (ILO) ILO Modelling Washington, 2012 1 / 27
  2. 2. Understanding growth and employment The traditional approachThe 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. 3. Understanding growth and employment A new methodConsidering 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. 4. Understanding growth and employment A new methodLabour 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. 5. Understanding growth and employment Overview of today’s talkOverview1 Modelling unemployment flows Research strategy What drives unemployment dynamics?2 A macro “wrapper” Modelling and estimation strategy A finance-augmented double Phillips curve3 Estimation and model dynamics Data and methodology Estimating the labour flow macro-model Model dynamics under shocks4 Shock transmission under different policy settings5 Concluding remarks E. Ernst (ILO) ILO Modelling Washington, 2012 5 / 27
  6. 6. Modelling unemployment flows Research strategyAiming 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. 7. Modelling unemployment flows Research strategyModel 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. 8. Modelling unemployment flows Research strategyModel 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. 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. 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. 11. Modelling unemployment flows What drives unemployment dynamics?Putting the pieces togetherSubstituting the flow equations: OUTt = JobCreationt INt = JobDestructiont + ∆Lt −1Hence: 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. 12. A macro “wrapper” Modelling and estimation strategyModelling methodology IStep-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. 13. A macro “wrapper” Modelling and estimation strategyModelling 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. 14. A macro “wrapper” A finance-augmented double Phillips curveFinancial 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. 15. A macro “wrapper” A finance-augmented double Phillips curveA 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. 16. Estimation and model dynamics Data and methodologyA 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
  17. 17. Estimation and model dynamics Estimating the labour flow macro-modelEstimation results: Labour block INt−1 ∆LFPRt−1 ∆Prodt−1 RIRSt−1 TaxIndt−1 Gapt ∆Wagest−1 (1) INt 0.620*** -7.084*** -5.702*** 0.008*** 1.284*** -0.018*** 0.254*** (0.021) (0.901) (0.434) (0.001) (0.313) (0.001) (0.090) OUTt−1 ETRt UCCt ∆Wagest ∆INVt Gapt (2) OUTt 0.595*** 1.812*** -0.009*** -0.940*** 3.303*** 0.024*** (0.017) (0.140) (0.001) (0.122) (0.240) (0.001) OUTt INt (3) ∆ETt 0.015*** -0.019*** (0.001) (0.002) ∆Wagest−1 πt−1 E {πt+1 } ∆Prodt ∆ETt−1 (4) ∆Wagest 0.640*** 0.178** 0.045* 0.487*** 0.255*** (0.040) (0.031) (0.027) (0.082) (0.042) ∆Prodt−1 ∆TFPt−1 (5) ∆Prodt 0.751*** 0.033** (0.065) (0.004) E. Ernst (ILO) ILO Modelling Washington, 2012 17 / 27
  18. 18. Estimation and model dynamics Estimating the labour flow macro-modelEstimation results: Macro block E {RIRSt+1 } GAPt NLGQt πt−1 (6) RIRSt 1.157*** 0.094*** -0.116*** -9.426*** (0.018) (0.021) (0.040) (1.384) RSharet RIRLt−1 RIRSt (7) RIRLt 0.700*** 0.419** 0.493*** (0.186) (0.012) (0.012) RSharet−1 ∆GovInvt−1 ∆Prodt−1 RIRLt−1 ∆ETt−1 (8) INVt 0.004* 2.687*** 0.678*** -0.001*** 0.547*** (0.002) (0.921) (0.116) (0.000) (0.034) OUTt−1 INt−1 ∆Wagest GovConst−1 (9) GAPt 1.090*** -4.390*** 4.971*** 8.062*** (0.131) (0.278) (1.357) (2.698) πt−1 E {πt+1 } ∆ToTt−1 ∆Wagest−1 (10) πt 0.449*** 0.533*** -0.049*** 0.041 (0.018) (0.028) (0.014) (0.029) E. Ernst (ILO) ILO Modelling Washington, 2012 18 / 27
  19. 19. Estimation and model dynamics Estimating the labour flow macro-modelEstimation 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. 20. Estimation and model dynamics Model dynamics under shocksUnemployment 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. 21. Estimation and model dynamics Model dynamics under shocksTransmission 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. 22. Shock transmission under different policy settingsPolicy 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. 23. Shock transmission under different policy settingsDynamic effects of changes in EPL I Higher EPL =⇒ weaker reaction of unemployment to adverse financial shocks 6.0 5.0 e) at 4.0 st nt y d e a m 3.0 et y ol s p mo m 2.0 f r e n n U oi t ai 1.0 v e d( 0 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. 24. Shock transmission under different policy settingsDynamic 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. 25. Shock transmission under different policy settingsChanges 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. 26. Concluding remarksLessons learned and outlookWhat 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 mechanismsNext 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. 27. BibliographyBibliography 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

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