Disinflation and the NAIRU in a New-Keynesian New-Growth Model

Rannenberg, Ansgar (2008): Disinflation and the NAIRU in a New-Keynesian New-Growth Model.

Abstract

Unemployment in the big continental European economies like France and Germany has been substantially increasing since the mid 1970s. So far it has been difficult to empirically explain the increase in unemployment in these countries via changes in supposedly employment unfriendly institutions like the generosity and duration of unemployment benefits. At the same time, there is some evidence produced by Ball (1996, 1999) saying that tight monetary policy during the disinflations of the 1980s caused a subsequent increase in the NAIRU, and that there is a relationship between the increase in the NAIRU and the size of the disinflation during that period across advanced OECD economies. There is also mounting evidence suggesting a role of the slowdown in productivity growth, e.g. Nickell et al. (2005), IMF (2003), Blanchard and Wolfers (2000). This paper introduces endogenous growth into an otherwise standard New Keynesian model with capital accumulation and unemployment. We subject the model to a cost push shock lasting for 1 quarter, in order to mimic a scenario akin to the one faced by central banks at the end of the 1970s. Monetary policy implements a disinflation by following a standard interest feedback rule calibrated to an estimate of a Bundesbank reaction function. About 40 quarters after the shock has vanished, unemployment is still about 1.7 percentage points above its steady state, while annual productivity growth has decreased. Over a similar horizon, a higher weight on the output gap increases employment (i.e. reduces the fall in employment below its steady state). Thus the model generates an increase in unemployment following a disinflation without relying on a change to labour market structure. We are also able to coarsely reproduce cross country differences in unemployment. A higher disinflation generated by a larger cost push shock causes a stronger persistent increase in unemployment, the correlation noted by Ball. For a given cost push shock, a policy rule estimated for the Bundesbank produces stronger persistent increase in unemployment than a policy rule estimated for the Federal Reserve. Testable differences in real wage rigidity between continental Europe and the United States, namely the presence of the labour share in the wage setting function for Europe with a negative coefficient but it's absence in the U.S. also imply different unemployment outcomes following a cost push shock: If the real wage does not depend on the labour share, the persistent increase in unemployment is about one percentage point smaller than in it's presence. To the extent that the wage setting structure is due to labour market rigidities, "Shocks and Institutions" jointly determine the unemployment outcome, as suggested by Blanchard and Wolfers (2000). We also perform a comparison of the second moments of key variables of the model with German data for a period ranging from 1970 to 1990. We find that it matches the data better than a model without endogenous growth but with otherwise identical features. This is particularly true for the persistence in employment as measured by first and higher order autocorrelation coefficients.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary Policy; Monetary Econmics; Unemployment; NAIRU; Natural Rate of Unemployment
• Subjects: O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O42 - Monetary Growth Models; E - Macroeconomics and Monetary Economics > E0 - General; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E30 - General; J - Labor and Demographic Economics > J0 - General > J01 - Labor Economics: General

References

Agell, J. (1999), On the Benefits from Rigid Labour Markets: Norms, Market Failures, and Social Insurance, in: The Economic Journal, Vol. 109, No. 453, pp. F143-F164.

Baker, D./ Glyn, A./ Howell, D./ Schmitt, J. (2002), Labor Market Institutions and Unemployment: A Critical Assessment of the Cross-Country Evidence, CEPA Working Paper 2002-17, CEPA.

Ball, L. (1996), Disinflation and the NAIRU, NBER Working Paper 5520.

Ball, L. (1999), Aggregate Demand and Long-Run Unemployment, in: Brookings Papers on Economic Activity, Vol. 199, No. 2, pp. 189-251.

Ball, L./ Moffitt, R. (2001), Productivity Growth and the Phillips Curve, NBER Working Paper 8421.

Bewley, Truman F. (1998), Why not cut pay?, in: European Economic Review 42 (1998), pp. 459-490.

Bewley, Truman F. (2004), Fairness, Reciprocity, and Wage Rigidity, in: IZA Discussion Paper No. 1137.

Barro, R.J./ Sala-i-Martin, X. (2004), Economic Growth, MIT Press.

Belot, M./ van Ours, J. (2004), Does the recent success of some OECD countries in lowering their unemployment lie in the clever design of their labor market reforms?, in: Oxford Economic Papers 56, pp. 621-642.

Blanchard, O. (2007), A Review of Layard, Nickell and Jackmann's Unemployment, in: Journal of Economic Literature, Vol. 65, No. 2, pp. 410-418.

Blanchard, O./ Katz, L.F. (1999), Wage Dynamics: Reconciling Theory and Evidence, in: The American Economic Review, Vol. 89.

Blanchard, O./ Wolfers, J. (2000), The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence, in: The Economic Journal, Vol. 110, No. 462, Conference Papers, pp. C1-C33.

Blanchard, O./ Summers, L. H. (1986), Hysteresis and the European Unemployment Problem, in: NBER Macroeconomics Annual, Vol. 1, pp. 15-78. Checci, D./ Lucifora, C. (2002), Unions and Labour Market Institutions in Europe, Working paper No. 16-2002 of the Dipartimento di Economica e Aziendale.

Christiano, Eichenbaum and Evans (2005), Nominal Rigidity and the Dynamic Effects of a Shock to Monetary Policy, in: Journal of Political Economy, Vol. 113, No. 1.

Clarida, R./ Gali, J., Gertler, M. (1998), Monetary Policy in Practice. Some international Evidence, in: European Economic Review, pp. 1033-1067.

Denis, C./ McMorrow, K./ Roeger, W. (2002), Production function approach to calculating potential growth and output gaps - estimates for the EU member states and the U.S. in: European Commission Economic Papers No. 176, http://europa.eu.int/comm/economy_finance.

Chadha, B./ Masson, M./ Meredith, G. (1992), Models of Inflation and the Costs of disinflation, in: Staff Papers - International Monetary Fund, Vol. 39, No. 2, pp. 395 - 431.

Danthine, J.-P. (2004), Fair Wages in a New Keynesian model of the business cycle, in: Review of Economic Dynamics 7, p107-142.

Elmeskov, J./ Martin, J./ Scarpetta, S. (1998), Key Lessons for Labor Market Reforms, in: Swedish Economic Policy Review 5, pp. 205-252.

Fitoussi, J. P./ Jestaz, D./ Phelps, E. S./ Zoega, G. (2000), Roots of the Recent Recoveries: Labor Reforms or Private Sector Forces?, in: Brookings Papers on Economic Activity 1, pp. 237-311.

Gali, J. (2001) New Perspectives on Monetary Policy, Inflation, and the Business Cycle, in: NBER Working paper 8767, http://www.nber.org/papers/w8767.

Gali, J./ Gertler, M. (1999), Inflation Dynamics: A structural Econometric Analysis, in: Journal of Monetary Economics 44, pp. 195-222.

IMF (2003), Unemployment and Labour Market Institutions: Why Reforms pay off, in: World Economic Outlook 2003, pp. 129-150.

Juillard, M. (1996), Dynare: A program for the resolution of and simulation of dynamic models with forward variables through the use of relaxation algorithm, CEPREMAP. Jondeau, E./ Bihan, H. (2005), Testing for the New Keynesian Phillips Curve. Additional international Evidence, in: Economic Modelling 22, pp. 521-550.

Layard, R./ Nickell, S./ Jackman, R. (1991), Unemployment. Macroeconomic Performance and the Labour Market, Oxford University Press.

Leslie, D. (1993), Advanced Macroeconomics. Beyond IS/LM, McGraw-Hill, London. Lubik, T.A./ Marzo, M. (2007), International Review of Economics and Finance 16, pp. 15-36.

Nickel, S/ Nunziata, L./ Ochel, W. (2005), Unemployment in the OECD since the 1960s. What do we know?, in: The Economic Journal, 115, pp. 1-27. Nickel, S./ Nunziata, L./ Ochel, W./ Quintini, G. (2002), The Beveridge Curve, Unemployment and Wages in the OECD from the 1960s to the 1990s, Centre for Economic Performance, London School of Economics.

Nolan, C./ Thoenissen, C. (2005), Labour Markets and Firm-Specific Capital in New Keynesian General Equilibrium Models, Centre for Dynamic Macroeconomic Analysis Working Paper Series, 05/01.

Pissarides, C./ Vallanti, G. (2005), The Impact of TFP Growth on Steady State Unemployment, CEPR Discussion Paper No. 5002.

Rodrik, D. (1998), Why do more open Economies have bigger Governments?, in: The Journal of Political Economy, Vol. 106, No. 5 pp. 997-1032.

Rotemberg, J. J./ Woodford, M. (1999), The Cyclical Behavior of Prices and Costs, in: NBER Working Paper No. 6909, National Bureau of Economic Research.

Solow, R./Orphanides, A. (1990), Money, Inflation and Growth, in: Friedman, B.M./Hahn, F.H. (Eds.) (1990), Handbook of Monetary Economics, Vol. 1, Elsevier Science Publishers B.V., pp. 224-261.

Skozylas, L./ Tisso, B. (2005), Revisiting recent Productivity Developments across OECD Countries, in: BIS Working Paper No. 182, BIS.

Smets, F./ Wouters, R. (2002), An estimated Stochastic Dynamic General Equilibrium Model of the Euro Area, in: ECB Working Paper No. 171.

Sargent, T./ Ljungqvist, L (1998), The European Unemployment Dilemma, in: The Jorunal of Political Economy, Vol. 106, No. 3.

Sargent, T./ Ljungqvist, L (2007), Understanding European unemployment with matching and search-island models, in: The Journal of Monetary Economics 54, pp. 2139-2179.

Statistisches Bundesamt Wiesbaden (2006a), Volkswirtschaftliche Gesamtrechnungen. Inlandsproduktberechnung. Revidierte Saisonbereinigte Vierteljahresergebnisse nach Census-X-12-ARIMA und BV4.1. 1970-1991, Statistisches Bundesamt Wiesbaden.

Statistisches Bundesamt Wiesbaden (2006b), Volkswirtschaftliche Gesamtrechnungen. Inlandsproduktberechnung. Revidierte Jahresergebnisse 1970 bis 1991, Statistisches Bundesamt, Wiesbaden.

Statistisches Bundesamt Wiesbaden (2007a), Volkswirtschaftliche Gesamtrechnungen. Inlandsproduktberechnung. Revidierte Saisonbereinigte Vierteljahresergebnisse nach Census-X-12-ARIMA und BV4.1. 2.Vierteljahr 2007, Statistisches Bundesamt Wiesbaden.

Statistisches Bundesamt Wiesbaden (2007b), Volkswirtschaftliche Gesamtrechnungen. Inlandsproduktberechnung. Revidierte Jahresergebnisse 1991 bis 2006, Statistisches Bundesamt, Wiesbaden.

Woodford, M. (2003), Interest and Prices. Foundations of a Theory of Monetary Policy. Princeton University Press, Princeton, New Jersey.

Woodford, M. (2004), Inflation and Output Dynamics with Firm Specific Investment, Princeton University, see: http://www.columbia.edu/%7Emw2230/capital.pdf