Working Paper: NBER ID: w22128
Authors: Matteo Cacciatore; Romain Duval; Giuseppe Fiori; Fabio Ghironi
Abstract: We study the consequences of product and labor market reforms in a two-country model with endogenous producer entry and labor market frictions. We focus on the role of business cycle conditions and external constraints at the time of reform implementation (or of a credible commitment to it) in shaping the dynamic effects of such policies. Product market reform is modeled as a reduction in entry costs and takes place in a non-traded sector that produces services used as input in manufacturing production. Labor market reform is modeled as a reduction in firing costs and/or unemployment benefits. We find that business cycle conditions at the time of deregulation significantly affect adjustment. A reduction of firing costs entails larger and more persistent adverse short-run effects on employment and output when implemented in a recession. By contrast, a reduction in unemployment benefits boosts employment and output by more in a recession compared to normal times. The impact of product market reforms is less sensitive to business cycle conditions. Credible announcements about future reforms induce sizable short-run dynamics, regardless of whether the announcement takes place in normal times or during an economic downturn. Whether the immediate effect is expansionary or contractionary varies across reforms. Finally, lack of access to international lending in the wake of reform can amplify the costs of adjustment.
Keywords: market reforms; business cycle; labor market; product market; economic policy
JEL Codes: E24; E32; F41; J64; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reduction of firing costs (J32) | Larger and more persistent adverse short-run effects on employment (J65) |
| Reduction of firing costs (J32) | Larger and more persistent adverse short-run effects on output (E44) |
| Reduction in unemployment benefits (J65) | Boost in employment (J68) |
| Reduction in unemployment benefits (J65) | Boost in output (E23) |
| Product market reforms (E69) | Economic outcomes (employment and output) (E24) |
| Credible announcements of future reforms (E69) | Substantial short-run dynamics (E19) |
| Announcement of future product market deregulation (L51) | Contractionary effects (E62) |
| Announcement of unemployment benefits reform (J68) | Expansionary effects (F41) |
| Lack of access to international lending during reform implementation (F34) | Amplified adjustment costs (G31) |