Abstract
This paper examines the length of economic adjustments to selected structural reforms, drawing on simulations with dynamic general equilibrium and macro-economic neo-Keynesian models. Employment adjustment costs appear to have only a limited effect on the pace of adjustment to reforms and the influence of price adjustment costs on output dynamics is found to be marginal. Accommodative monetary policy can speed up the adjustment to a new equilibrium, though to a varying degree in the different OECD countries or regions. In particular, reforms in individual euro area countries are likely to trigger only little or no policy reaction, unless there is an area-wide effort to implement structural reforms.
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Notes
A partial remedy is to use a two-step procedure, where the Non Accelerating Inflation Rate of Unemployment (NAIRU) or mark-up shock is first calibrated off model using external information, for example, on the impact of institutions in a reduced-form unemployment equation, and then simulated within the macroeconomic model. However, this strategy leads to unbiased estimates only if other direct or indirect effects of institutions on economic performance can be neglected.
For instance, Coenen et al. (2007) examine the effects of temporary fiscal measures. Everaert and Schule (2006) use the IMF's global economy model to explore transitory costs of reforms. Imperfect competition in labour and product markets is modelled in a stylised manner through the existence of mark-ups. Similarly, Kilponen and Ripatti (2005) have investigated the quantitative effects of an increase in competition in both product and labour markets. Batini et al. (2005) examine the impact of combined fiscal adjustment and structural reforms for Japan.
Removing the country fixed effects and institutional variables that do not come out significant in the Bassanini and Duval equation would increase the level estimate of structural unemployment, without significantly modifying its profile.
It should be noted, however, that a national-accounts based measure of the tax wedge would lead to a lower contribution.
For this exercise OECD Economic Outlook NAIRUs rather than structural unemployment rates have been used, as the latter are by construction correlated with institutions. NAIRUs and structural unemployment rates usually display similar trends in OECD countries, but levels differences can be observed for some countries.
A simple rule of thumb derived from regression analysis is that the correlation is significant when it exceeds 0.1 in absolute value.
As the transition dynamics are very similar for different reform measures, the discussion of impulse response patterns focuses on labour tax cuts, however. Impulse responses for benefit and product market reforms are displayed in Mourougane and Vogel (2008).
See Cahuc and Zylberberg (2004) for an excellent overview on labour adjustment costs.
An implication is that no long-term complementarities between reforms increasing flexibility and reforms increasing labour supply can be found in our simulations.
Similar results are found for a reduction of the benefit replacement ratio and a cut in employer social security contributions. See Mourougane and Vogel (2008).
Contrary to the baseline model, labour adjustment costs also affect the steady state production and consumption level in the search-and-matching framework. As there are separations in each period, positive adjustment costs will even accrue in the steady state, reducing the level of consumption and equilibrium employment.
Because consumption equations have not been estimated over the same period in the United States and the euro area, the traditional result (eg Angeloni et al., 2003b) that consumption is more sensitive to interest rates in the United States than in the euro area does not apply in this simulation. Hence, differences in the adjustment process between the United States and the euro area in the presence of monetary reaction may even be understated.
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Acknowledgements
The authors especially thank Jørgen Elmeskov, who had the initial idea for this paper. They are grateful to Jonathan Coppel, Davide Furceri, Claude Giorno, Peter Hoeller, Vincent Koen and Jean-Luc Schneider for helpful discussions and suggestions. We also thank the participants of the 14th Dubrovnik Conference, in particular Maroje Lang.
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Mourougane, A., Vogel, L. Speed of Adjustment to Selected Labour Market and Tax Reforms. Comp Econ Stud 51, 500–519 (2009). https://doi.org/10.1057/ces.2009.12
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DOI: https://doi.org/10.1057/ces.2009.12