Understanding the Gains from Wage Flexibility: The Exchange Rate - - PowerPoint PPT Presentation
Understanding the Gains from Wage Flexibility: The Exchange Rate Connection Jordi Gal Tommaso Monacelli October 2013 Jordi Gal, Tommaso Monacelli () Wage Flexibility and the Exchange Rate October 2013 1 / 16 Gains from Wage Flexibility:
Jordi Galí Tommaso Monacelli October 2013
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate October 2013 1 / 16
Conventional wisdom (I): "Wage flexibility is a good thing"
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 2 / 16
Conventional wisdom (I): "Wage flexibility is a good thing" Conventional wisdom (II): "Wage flexibility is a good thing. More so in a currency union"
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 3 / 16
Conventional wisdom (I): "Wage flexibility is a good thing" Conventional wisdom (II): "Wage flexibility is a good thing. More so in a currency union" Recurrent calls for wage moderation and reforms to enhance wage flexibility, aimed at troubled euro are countries
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 4 / 16
Closed economy model with staggered price and wage setting Taylor-type interest rate rule: it = ρ + φππt + φyyt Indirect effect of wages on employment: ↓ w ⇒ ↓ π ⇒ ↓ i ⇒ ↓ r ⇒ ↑ y ⇒ ↑ n ⇒ key role for endogenous monetary policy response Main finding: Increased wage flexibility may be welfare-reducing if φπ is small
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 5 / 16
Closed economy model with staggered price and wage setting Taylor-type interest rate rule: it = ρ + φππt + φyyt Indirect effect of wages on employment: ↓ w ⇒ ↓ π ⇒ ↓ i ⇒ ↓ r ⇒ ↑ y ⇒ ↑ n ⇒ key role for endogenous monetary policy response Main finding: Increased wage flexibility may be welfare-reducing if φπ is small
Caveat: closed economy, no room for "competitiveness channel"
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 6 / 16
Framework: small open economy New Keynesian model GM 2005 + wage rigidities Transmission of wage changes to employment:
Questions:
The exchange rate connection: with a more rigid exchange rate, wage flexibility is... ⇒ more valuable to bring about warranted changes in terms of trade ⇒ less effective due to muted monetary policy response
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 7 / 16
Domestic households E0
∞
t=0
βtU(Ct, Nt; Xt) Ct ≡
1 η CH,t
1− 1
η + ν 1 η CF ,t
1− 1
η
η−1
CH,t ≡ 1
0 CH,t(j)
ǫp −1 ǫp dj
ǫp −1
U(Ct, Nt; Xt) =
1 1 + ϕN1+ϕ
t
where xt ≡ log Xt ∼ AR(1) ("demand shock") Assumption: access to (complete) international financial markets
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 8 / 16
Domestic firms Yt = AtN1−α
t
where at ≡ log At ∼ AR(1) ("technology shock") Monopolistic competition in goods and labor markets Staggered price and wage setting à la Calvo Producer currency pricing (full pass-through) Monetary policy it = φππH,t + φe 1 − φe et Limiting case: as φe → 1, exchange rate peg (et = 0)
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 9 / 16
Exogenous payroll tax process τt = ρττt−1 + ετ
t
Baseline calibration:
Response of employment to a 1% payroll tax cut, as a function of φe
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 10 / 16
Labor demand nt = 1 1 − α(yt − at) Equilibrium output yt = (1 − ν)ct + ην(2 − ν)st Equilibrium consumption: ct = xt − (1 − ν)Et
k=0
(it+k − Et{πH,t+1+k})
st = −Et
k=0
(it+k − Et{πH,t+1+k})
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 11 / 16
Interaction between:
Welfare loss in the unit-elasticity case (η = 1) L ∼ (1 + ϕ) var( nt) +
λp(1 − α)
t ) +
ǫw λw
t )
Conditional analysis: (i) demand shocks (ii) technology shocks
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 12 / 16
w
w
Interaction between:
Welfare loss in the unit-elasticity case (η = 1) L ∼ (1 + ϕ) var( nt) +
λp(1 − α)
t ) +
ǫw λw
t )
Conditional analysis: (i) demand shocks (ii) technology shocks Robustness to alternative calibrations:
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 13 / 16
Conventional wisdom "Wage flexibility is a good thing. More so in a currency union"
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 14 / 16
Conventional wisdom "Wage flexibility is a good thing. More so in a currency union" Finding #1: Effectiveness of labor cost adjustments on employment inversely related to exchange rate "rigidity" ⇒ least effective in a currency union
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 15 / 16
Conventional wisdom "Wage flexibility is a good thing. More so in a currency union" Finding #1: Effectiveness of labor cost adjustments on employment inversely related to exchange rate "rigidity" ⇒ least effective in a currency union Finding #2: Increased wage flexibility often welfare-reducing. ⇒ more likely so in a currency union.
Jordi Galí, Tommaso Monacelli () Wage Flexibility and the Exchange Rate December 2013 16 / 16
1 1.2 1.4 1.6 1.8 2 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 100 200 300 400 500 600 Inflation Coefficient Wage Stickiness Welfare losses
1 1.2 1.4 1.6 1.8 2 0.2 0.4 0.6 0.8 1 50 100 150 Inflation Coefficient W a g e S t i c k i n e s s Welfare losses: Employment component
1 1.2 1.4 1.6 1.8 2 0.2 0.4 0.6 0.8 1 50 100 150 200 250 Inflation Coefficient Wage Stickiness Welfare losses: Wage Inflation Component
1 1.2 1.4 1.6 1.8 2 0.2 0.4 0.6 0.8 1 200 400 600 Inflation Coefficient Wage Stickiness Welfare losses: Price Inflation Component