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Linzert Presentation

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Business-Finance

Published on January 13, 2009

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Slide 1: Identifying the Role of Labor Markets for Monetary Policy in an Estimated DSGE Model Kai Christoffel, Keith Kuester, Tobias Linzert European Central Bank International Research Forum on Monetary Policy 1-2 December 2006, Washington D.C. Disclaimer: The views expressed in this paper are those of the authors and do not necessarily reflect the views of the European Central Bank Slide 2: Labor important factor of economic activity Wages are crucial for firm’s production cost European labor markets deviate from spot competitive markets high and persistent unemployment, wage rigidities, etc. ? Labor market may be important for business cycle fluctuations, monetary policy transmission and welfare Motivation Slide 3: Labor market frictions and wage rigidities may be important for monetary policy in three ways: Labor market structure: Speed of labor market adjustment may affect the transmission of monetary policy to inflation Labor market shocks may have direct implications for inflation dynamics and hence for the central bank’s objective of stabilizing inflation Welfare implications: Labor market regime may be key for the optimal design of monetary policy Motivation Focus of this Paper : Focus of this Paper Employ small-scale (Keynesian) DSGE model with: Matching frictions a la Mortensen/Pissarides (Walsh, 2004; Trigari, 2006) Real wage rigidity (Hall, 2005; Blanchard/Gali, 2006) Right-to-manage bargaining (Trigari, 2006; Christoffel/Linzert, 2005) Estimate/calibrate (Bayesian) from 1977 to 2004 for German data as proxy for EMU Optimal monetary policy in a model with labor market frictions Central Questions : Central Questions Examine importance of labor market for monetary policy and the business cycle How does the labor market structure affect the transmission process of monetary policy? How is inflation affected by labor market shocks? Should monetary policy react to the state of labor market? Preview of Results : Preview of Results Labor market structure matters for transmission of monetary policy, especially rigid wages translate into more inflation persistence Labor market shocks hardly transmit to traditional New Keynesian side of the economy Particularly, wage rigidities are key for optimal monetary policy Model Structure : Monetary authority Households search for work consume/save perfect consumption insurance vacancy posting sell in competitive market Intermediate good firms Wage bargaining Wholesale sector (Calvo) produce differentiated goods monopolistic competition price indexation Real price: Model Structure Labor Market Features : Labor Market Features Right-to-Manage Bargaining Firms and workers bargain over wages to maximize expected joint surplus from employment: s.t. Hours are chosen by the firm according to labor demand curve Marginal cost of an hour worked is determined by the wage Labor Market Features : Labor Market Features Worker’s and firm’s surplus from employment: Worker’s surplus: Firm’s surplus: Labor Market Features : Labor Market Features Real Wage Rigidity: Once matched, firms and workers bargain over real wage subject to adjustment costs The Wage to Inflation Channel : The Wage to Inflation Channel Linearized wage equation: with Real wage rises (given positive parameters) with mrs, vacancy costs and market tightness (v/u) Decreasing returns to labor (individual firm level) : change in total match surplus when wage marginally increases Last term: smoothing. If surplus increases more in w (falls less) tomorrow, postpone part of wage increase The Wage to Inflation Channel : The Wage to Inflation Channel Marginal cost: Wages increase the cost of the intermediate good directly Contrasts with efficient Nash bargaining Phillips Curve: Bayesian Estimation : Bayesian Estimation Quarterly OECD data for Germany from 1977:1 to 2004:2. Linearly de-trended and de-meaned. Observable variables: consumption, inflation, interest rates, employment and real hourly wages Shocks: cost push, consumption time-preference, inflation target, disutility of work, technology and labor market shock (shock to vacancy costs) Calibration : Calibration Markup: 10% Labor share: 0.72 (? a=.792) Discount factor: ß=.99 Elasticity of intertemporal substitution of labor: 1/F=.1 Log consumption utility Separation rate: ?=0.08 ?15% of labor force search for a new job each period (consistent with German data) Vacancies: 2/3 the number of searching workers Bargaining power of workers: ?=0.2 Implied Steady State : Implied Steady State Probability of finding a worker within a quarter: q = 0.7 Probability of finding a job within a quarter: s = 0.47 Replacement rate: 50% Cost of posting a vacancy: 1.5 quarters of a typical firm‘s production (sizeable but reasonable) Bayesian Estimation Results : Bayesian Estimation Results Model Dynamics : Model Dynamics Impulse response analysis: Monetary policy shock (inflation target) Vacancy posting cost shock Policy counterfactuals: Wage rigidity Labor market flexibility Forecast error variance decomposition Slide 20:  Forecast Error Variance Decomposition At medium term: demand preference shock and tech. shock drive economy. Vacancy shock matters for labor market. But little transmission in the model economy. Slide 21:  Forecast Error Variance Decomposition Optimal Policy : Optimal Policy Levin, Onatski, Williams, Williams (2005): central importance of labor markets for welfare. Our model has monopolistic distortions, price distortions, wage rigidity plus search externalities + eqbm unemployment. It is ultimately an empirical questions whether additional labor market frictions change the prescriptions for optimal policy. monetary policy should react directly to labor market developments. Optimal Policy vs. Estimated Rule : Optimal Policy vs. Estimated Rule Do additional labor market frictions change the prescriptions for optimal policy? Optimal Simple Policy Rules : Optimal Simple Policy Rules Should monetary policy react directly to labor market developments ? Conclusions : Conclusions Labor market structure matters for transmission of monetary policy and specifically inflation dynamics ? Labor markets may help to understand cross country differences in inflation dynamics Labor market shocks hardly transmit to traditional New Keynesian side of the economy Conclusions : Conclusions Monetary Policy should not respond to unemployment Wage rigidities are key for optimal monetary policy ? Stabilizing inflation and wage inflation outperforms the traditional Taylor rule Future Research : Future Research Optimal monetary policy How does monetary policy react to labor market developments Stabilization policy might depend on the degree of rigidity of the labor market Country comparisons (rigid vs. more flexible labor markets) Relaxing income pooling assumption: introduce heterogeneity to the model (liquidity constrained consumers, etc.) The Model - Households : The Model - Households Households consume and save search for work households pool income, i.e. perfect consumption insurance The Model – The linearized profit condition : The Model – The linearized profit condition Profits in the right-to-manage bargaining: Coming from the linearized profit function coupled with the FOC of hours Data : Data Bayesian Estimation Results : Bayesian Estimation Results Bayesian Estimation Results : Bayesian Estimation Results Model Fit : Model Fit

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