Working Paper: NBER ID: w21784
Authors: Matteo Cacciatore; Romain Duval; Giuseppe Fiori; Fabio Ghironi
Abstract: This paper explores the effects of labor and product market reforms in a New Keynesian, small open economy model with labor market frictions and endogenous producer entry. We show that it takes time for reforms to pay off, typically at least a couple of years. This is partly because the benefits materialize through firm entry and increased hiring, both of which are gradual processes, while any reform-driven layoffs are immediate. Some reforms—such as reductions in employment protection—increase unemployment temporarily. Implementing a broad package of labor and product market reforms minimizes transition costs. Importantly, reforms do not have noticeable deflationary effects, suggesting that the inability of monetary policy to deliver large interest rate cuts in their aftermath—either because of the zero bound on policy rates or because of membership in a monetary union—may not be a relevant obstacle to reform. Alternative simple monetary policy rules do not have a large effect on transition costs.
Keywords: Market Deregulation; Monetary Policy; Small Open Economies; Labor Market Reforms; Product Market Reforms
JEL Codes: E24; E32; E52; F41; J64; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| labor market reforms (J48) | immediate layoffs (J63) |
| immediate layoffs (J63) | increased unemployment (J65) |
| labor market reforms (J48) | increased unemployment (J65) |
| increased unemployment (J65) | reduced real wages (J39) |
| labor market reforms (J48) | job creation (J68) |
| job creation (J68) | increased employment (J68) |
| labor market reforms (J48) | increased consumption (E21) |
| product market reforms (E69) | firm entry (M13) |
| firm entry (M13) | increased competition (L13) |
| increased competition (L13) | long-term gains in consumption (D15) |
| increased competition (L13) | long-term gains in employment (J68) |
| monetary policy constraints (E52) | complicate transition dynamics (C69) |