The Clash of Central Bankers with Labour Market Insiders, and the Persistence of Inflation and Unemployment

This paper analyses the implications of monetary policy for the dynamic behaviour of inflation, in a ‘natural’ rate model characterized by endogenous unemployment persistence. We present evidence for the main industrial economies which suggests that inflation displays persistence which is of the same order of magnitude as the persistence of deviations of unemployment from its ‘natural’ rate. We provide a theoretical explanation of this fact based on a model of the dynamic interactions between central bankers and labour market insiders. The clash in the objectives of central bankers and labour market insiders is what causes both inflation and unemployment to display the same degree of persistence in this model. The analysis suggests that inflation persistence could be addressed in a welfare-improving way, if central banks adopted monetary policy rules that targeted unanticipated changes in unemployment rates instead of deviations of unemployment from its ‘natural’ rate.

Economica, Early View, 15 May 2017

PDF of Accepted Manuscript

 

 

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On the Persistence of Unemployment

A comparison of unemployment across fourteen European countries, Japan and the US shows a great diversity of persistence: high in most of Europe outside the Scandinavian countries, Austria and Switzerland, low in Japan and the US.

Three reasons for unemployment persistence are examined. First, employed workers may not care about the unemployed, and only wish to protect their own jobs. The authors find little support for this view, except perhaps in the US. Second, workers may be reluctant to revise downward their wage aspirations. This seems to be the case in Europe, as opposed to the US and Japan. Third, firms may be slow in adjusting employment to its optimum level. This is the case in Europe and Japan, not in the US.

Labour market reforms might help, but have their own costs. The authors conclude that the best course of action is a demand expansion combined with incomes policies.

Economic Policy (with Alan Manning)

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Wage Setting and Unemployment Persistence in Europe, Japan and the USA

In this paper we set out to directly distinguish between insider membership dynamics and other sources of unemployment persistence. Our findings suggest that there are not sufficient differences in insider membership dynamics between the European economies and the United States. Thus, one cannot appeal to this source to justify the difference in their unemployment experience after the mid-seventies. This is in marked contrast to the conclusion of Blanchard and Summers. We suggest that their conclusions are sensitive to the way of approximating the natural rate of unemployment. Our second conclusion concerns sluggishness in labour demand. We find evidence of significant sluggishness in the three European economies and no sluggishness in the U.S.A. and Japan. This tentatively suggests that the persistence of European unemployment after the recent demand and supply shocks may have to do with this source.In section 2 we briefly present a version of the Blanchard and Summers model of wage and employment setting. In section 3 we modify and extend the model, and present estimates of the hysteresis coefficient, that measures the extent to which past employment determines the size of the group of insiders in wage negotiations. In section 4 we briefly investigate sluggishness in labour demand, and the conclusions are summed up in the final section.

European Economic Review (with Alan Manning)

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