The Positive Economics of Labor Market Rigidities and Investor Protection

This paper presents a positive model which shows that institutional setups on capital and labor markets might be intertwined by politicoeconomic forces. Some countries especially in continental Europe exhibit a corporatist politicoeconomic equilibrium with a substantial protection of insiders on both markets. The more important money is in political decision-making, the more divided the workforce is, and the more globalized capital markets are, the more likely is a capitalist politicoeconomic equilibrium with little employment and substantial investor protection. Our prediction of a negative cross-country relationship between labor market rigidities and of competition on capital markets receives considerable empirical support.Labor markets, employment protection, corporatism, corporate governance, shareholder protection, political economy

The positive economics of corporatism and corporate governance

This paper presents a positive model which shows that institutional setups on capital and labor markets might be intertwined by politicoeconomic forces. Two politicoeconomic equilibria arise from our model, one with little protection of insiders on capital and labor markets, and another one with an institutional bias toward favoring insiders on both markets. Coherent and relatively homogeneous societies, where binding commitments enjoy greater feasability, are more likely to be found in the latter, corporatist equilibrium, whereas fragmented, heterogeneous Anglo-Saxon societies fit better into the former category. These predictions of the model receive considerable support in our crosscountry empirical analysis, thus being potentially important for the current debates concerning the reforms of labor markets and of corporate governance systems. --

Did the Bundesbank Follow a Taylor Rule? An Analysis Based on Real-Time Data

Using a real-time data set for German GDP over the period from 1973 to 1998 we calculate various measures of real-time output gaps and use these to calibrate and estimate Taylor-type reaction functions for the Bundesbank. Most of the reaction functions we find fit the Bundesbank´s actual policy, as represented by the short-run interest rate, quite well. In contrast to previous findings based on ex post revised data for the output gap, we find the reaction coefficients to resemble quite closely those originally proposed by Taylor for some of our real-time measures of the output gap. Broad monetary aggregates such as M3, in contrast, only played a small role for the Bundesbank´s interest rate decisions. Given the good record of the Bundesbank in fighting inflation, the results give support for the use of the Taylor rule for monetary policy.German real-time data; output gap; monetary policy rules

Euroland: Strong upswing, risks to price level stability

The Euroland economy is in a strong upswing. Last year, real GDP increased at a rate roughly equal to that of potential output in spite of the export losses in the wake of the crises in various countries of the world. There have been considerable impulses from monetary policy. Because of the strength of the economy, the ECB has started to tighten its policy. Nevertheless, monetary conditions in the euro area are still favorable. In 2000, real GDP is likely to increase by 3.2 percent; this is the highest rate in the past ten years. After a weak start, the economy gained considerable momentum in the course of 1999. While the strong export performance was responsible for the turnaround, domestic demand growth also accelerated somewhat. In the second half of 1999, real GDP increased at an annual rate of 3.5 percent, and capacity utilization should have reached its normal level by now. Inflation picked up in the course of 1999 with rates between 1.5 and 2.0 percent, thus coming close to the upper limit of the target range tolerated by the ECB. The driving force so far were higher import prices. Since November, the ECB has raised key interest rates by 100 basis points to 3.50 percent. This is the first tightening of monetary policy since the fall of 1997. The expansion of M3, however, indicates that monetary policy continues to be expansionary. Last year, the reference value for money growth was exceeded considerably. The interest rate hikes must be seen against this background. They were the logical consequence in the concept which is based on money growth. In the present situation, rules for monetary policy also suggest a tightening. The McCallum Rule pertains to the growth rate of the money stock M3 that is compatible with the inflation target and the trend changes in output and velocity. Since early 1999, money growth has been higher than the rate implied by the rule. If this tendency continued, inflation would exceed 2 percent. In order to avoid this, interest rates have to go up. Similarly, the Taylor Rule suggests that interest rates need to be higher because capacity utilization is at its normal level and will rise further. The countries in the euro area have come closer to the target of the Stability and Growth Pact as budget deficits have declined. Next year, fiscal policy will be characterized by tax cuts in a number of countries. The strongest impulse will come from the tax reform in Germany. For Euroland as a whole, the stance of fiscal policy will thus become expansionary. In general, there appears to be a shift in the strategy of fiscal policy: While deficits were reduced on the road to EMU also by increases in taxes and contributions, the revenue/GDP ratio will decline in the coming three years according to the plans of governments. Spending is supposed to decline even more so that deficits will shrink. Such a strategy can be highly recommended. According to empirical estimates, fiscal policy has contributed to the decline in the potential growth rate in the past 30 years by expanding the share of government spending in GDP. While leading indicators point to a strong expansion of economic activity in the near future, several factors will lead to a moderate slowdown of the upswing later this year and in 2001. The recovery in the world economy will lose some momentum and the effect of the weaker euro will gradually fade. Furthermore, the ECB will raise interest rates again. An impulse for the upswing, however, will result from the turnaround of fiscal policy. All in all, real GDP growth will amount to 3.2 percent this year and will go down to 2.8 percent in 2001. The unemployment rate will continue to fall; next year, it'will drop to below 9 percent for the first time since 1992. Consumer prices will rise a lot faster than in 1999. Although the inflation rate will decline somewhat in the course of this year because import prices will moderate, the core rate of inflation will go up due to the marked rise in capacity utilization. The Harmonized Index of Consumer Prices will increase by 1.9 percent this year and by 1.8 percent next year. The weakness of the euro has a stimulating effect on output in the euro area which is equivalent to roughly half a percentage point of GDP. If the trade links of the individual EMU countries with the dollar area are taken into account, it can be shown that the effects are spread more or less symmetrically across the economies. --

Higher economic growth through macroeconomic policy coordination? The combination of wage policy and monetary policy

Strengthening potential output is high on the agenda for economic policy in the European Union. While there is widespread agreement that structural policies have a positive impact on long-term growth, there is a controversial discussion whether coordination of macroeconomic policies can contribute to this goal. Against the background of the new economic conditions in the euro area, we analyze what could be gained from a combination of wage policy and monetary policy. Using a small theoretical macroeconomic model, we show that coordination between wage policy and monetary policy can be beneficial under certain assumptions. A policy of sustained wage moderation results in an increase in employment and potential output. Assuming that expectations are not completely forward-looking and prices are sticky, the upward shift in potential output will not be matched by a similar increase in aggregate demand. To prevent an output gap from emerging, the optimal monetary policy is to lower interest rates. However, a central bank aiming at price stability will only do so when the announcement of a policy of sustained wage moderation is credible. Simulations with a large macroeconometric multicountry model confirm that a coordination of German wage policy and ECB monetary policy would help to realize the beneficial effects of wage moderation somewhat faster, although the quantitative effect is relatively small. The long-run gain in employment would accrue regardless of a coordination with monetary policy. According to the simulations, employment in Germany would increase by about 750,000 persons in the long run if wages increase one percentage point slower than usual over a period of five years. Frequently, countries with a particularly positive economic development are said to have benefited from a coordination of macroeconomic policies. However, only a small part of the growth and employment success in these countries can be accounted for such a coordination. In the case of the United States, it is hard to see any evidence of ex ante policy coordination at all. In the Netherlands and in Ireland, a consensual strategy of wage restraint for improving the competitiveness of the economy and stimulating employment has been a significant factor of the economic success. It was important in both cases that significant supply side reforms were implemented by the governments at the same time, whereas monetary policy played no active role. Coordination of macro policies is severely complicated by the pronounced differences in national wage bargaining systems. The systems would have to be harmonized and centralized to create a single European wage policy. It is, however, unlikely that centrally designed harmonization of labor market institutions in the EU can cope with the differences across Euroland regarding productivity and employment. In the framework of the European Union, the presumed positive effects of policy coordination are stressed over and over again, for example in the Broad Economic Policy Guidelines. However, clear definitions and mechanisms how such a coordination can be achieved are missing. The fundamental difficulty concerning a coordination between wage policy and monetary policy arises from two facts: First, there is no such thing as “the” wage policy at the European level. Second, the statute of the ECB does not allow a binding commitment by the central bank. This does not mean, however, that the ECB would not take account of what is happening, for example, to wage developments. According to the monetary policy strategy, it should react if there is an increase in the growth rate of potential output as a result of wage moderation. For example: If the social partners in a large country such as Germany give a credible signal that wage increases will be moderate for several years, the ECB could accommodate this change. However, such a strategy cannot be reversed in that the ECB moves first hoping that wage moderation will follow. --

Evidence of the new economy at the macroeconomic level and implications for monetary policy

The notion of new economy was coined in the United States when there was increasing evidence that, as a result of the introduction of new technologies, the traditional behavior of macroeconomic variables might have changed. The expansion of the 1990s differed from its predecessors in three important respects: productivity, inflation, and cyclical variability. In the United States, labor productivity increased much faster in the 1990s than in the previous decades and, contrary to the usual pattern, accelerated with the duration of the expansion. The view that most of the productivity acceleration was only cyclical and therefore not sustainable over a longer period of time has proven overly pessimistic. Productivity growth has remained on its elevated since the economy peaked. In other large industrial countries, by contrast, productivity growth has continued to decline or has improved only very slightly at best. Differences in productivity trends between the United States and other large industrial countries can be explained partly by the fact that in the United States IT production is more important and IT implementation relatively advanced. In addition, the identification of IT-related productivity gains in Europe is complicated by the general trend towards deregulation in labor and product markets and moderate wage increases that contributed to a rise in labor intensity, which tends to lower advances in productivity. In contrast to productivity developments, the behavior of inflation is consistent with a new economy in all large industrial countries. The moderate inflation can, however, be explained by adequate monetary policies and cyclical influences. Similarly, the analysis of cyclical variability concludes that changes in economic policies are a more important factor in explaining the reduced fluctuations in U.S. GDP than the advent of IT. A technology shock which raises the permanent level of output and, at least temporarily, the growth rate of the production potential has implications for monetary policy. In a world with rational expectations and sticky prices, the optimal reaction of monetary policy to an acceleration of potential output growth is to raise interest rates. The reason is that the expectation of higher incomes in the future causes current spending to grow faster than potential output and thus leads to inflationary pressure. In reality the optimal response of monetary policy to a shift in production potential is difficult to assess given the uncertainty concerning the timing and magnitude of new economy effects on the real economy. Being too expansionary probably has more severe consequences than erring on the other side, because the positive real effects would work through anyway, while inflationary expectations, once triggered, are difficult to reduce. --

Moderate upswing in Euroland

Economic activity in the euro area is recovering. In the second half of 2003, real GDP grew at an annualized rate of roughly 1½ percent. In contrast with other large industrialized countries, economy-wide capacity utilization has not yet increased. Private consumption has remained the major weak point. However, private investment has increased for the first time since 2½ years and exports have risen rapidly, stimulated by the strong upswing in the rest of the world. A number of leading indicators suggest that the recovery in Euroland has gained some momentum since the turn of the year. Despite an expansionary monetary policy and the dynamic world economy, real GDP in the euro area will rise only moderately in comparison with earlier upswings. This is due to two factors. First, potential output growth in the euro area has apparently decelerated. Second, fiscal policy especially in the large euro-area economies is not sustainable. As governments do not have a credible consolidation strategy, the tax burden is likely to increase in the coming years. Against this background private households? income prospects are subdued and, as a consequence, private consumption will remain comparatively weak. The appreciation of the euro has had a considerable effect on economic activity, but it will not stop recovery. The results of our macroeconometric model imply also that the effects will be small in 2005 if, as we assume, the euro/ dollar exchange rate remains unchanged. Some observers urge the ECB to react to the strength of the euro by cutting interest rates. Whether the ECB should do so depends solely on the way in which the appreciation of the euro impacts the targets embedded in its monetary policy strategy. The main issue is whether the appreciation of the euro will push the inflation rate considerably below the target value. Past experience suggests that it would be unwise to assume it will have a strong dampening effect on consumer prices. Since the beginning of monetary union inflation forecasts have usually been too optimistic. All in all, the ECB is well advised not to cut interest rates in response to recent exchange rate developments. Interest rates in the euro area are already unusually low and stimulate economic activity. The Stability and Growth Pact requires the governments in euro-area countries to achieve a balanced budget or a budget surplus in the medium run. The main problem at present is not that budget deficit to GDP ratios are higher than 3 percent in some countries, but that structural deficits are also very high. Seven years after the adoption of the Pact the large countries still have made no progress on the way to a balanced budget. In Germany and France the structural deficits are even higher than before the monetary union. The recent Stability Programs of these countries suggest that the balanced- budget target has been given up altogether. This is eroding the credibility of fiscal policy and constitutes a heavy blow to economic stability in the euro area. Unsound fiscal policy negatively affects expectations in the private sector and is likely to result in a further deceleration of potential output growth. --

Strong exports and low interest rates drive Euroland's economy

In the fall of 1999, the recovery in Euroland is back on track. The turnaround was caused by the improvement in the world economy. After exports had been depressed in the past winter due to the weak demand in the crisis countries particularly in Asia, the impulses from abroad have picked up again. Furthermore, monetary policy has been expansionary, especially after the reduction of key interest rates in April this year. All in all, the upswing will gain momentum and will continue in the year 2000. In this paper, rules for monetary policy which are being discussed in the literature are used to gauge the stance of monetary policy. The conclusion is that interest rates will have to be raised if the reference path for money shall not be exceeded and if the target for inflation shall be achieved. Furthermore, the differences in growth rates of output across Euroland's economies are analyzed; it is found that there has been no significant convergence of income levels during the past decade. Finally, it is analyzed why inflation rates have differed in recent years. The main reason appears to be that the prices for nontradables in the various countries show different rates of change over time. Since such differences can also be expected for the future, inflation rates will not be equal, i.e., there will also be changes in real exchange rates in the monetary union. However, there is no reason for monetary policy to be concerned about this. --

Euroland: recovery will slowly gain momentum

Economic activity in the euro area has weakened since last summer. In the second half of 2002, real GDP increased at an annualized rate of around 1 percent only. Economy-wide capacity utilization has further declined and the situation on labor markets has worsened. The increase in consumer prices has calmed down somewhat after an acceleration at the beginning of last year. Still, the inflation rate remains surprisingly high against the background of weak economic activity that has already lasted for two years. Monetary policy in the euro area is clearly expansionary. With only about 0.5 percent, the real interest rate is currently quite low by historical standards. Moreover, the nominal interest rate is well below the rate implied by the standard Taylor rule, even when low estimates of the current size of the output gap and the equilibrium real interest rate are employed in the calculation of the rule. Still, monetary policy is probably not too expansionary. According to theory, the equilibrium real interest rate may be substantially below the long-run average real interest rate in situations such as the current one with depressed income and profit expectations. However, these considerations also imply that the ECB should bring the real interest rate back towards the long-run average once the depressing factors will have vanished. The situation of public finances in the euro area deteriorated further in the course of last year, with the aggregated budget in the countries of the euro area approaching a deficit of 2.3 percent of GDP in 2002. The cyclically adjusted budget deficit in the euro area was as high as in 1998, the year immediately before the beginning of the third stage of the Economic and Monetary Union. Whereas most countries have in the meantime complied with the goal of the Stability and Growth Pact to at least balance the budget over the medium term, the budget deficit in Germany, France, Italy and Portugal remained high both in actual and in structural terms. The governments of the three largest countries of the euro area are not likely to switch towards a policy of fiscal consolidation based on cuts in primary spending in 2003 and 2004. Moderate wage settlements would be appropriate in the current cyclical situation. However, wage increases have not slowed down over the past year, and are not expected to do so to any meaningful extent this year and next, reflecting the judgment that labor market rigidities will remain significant over the forecast horizon. Nevertheless, as employment is likely to be slow in responding to a recovery in production, the rise in unit labor costs will decelerate considerably, improving the chances that inflation will fall persistently below 2 percent. The leading indicators suggest that economic activity in the euro area will remain weak in the first half of this year. Under the assumption that the war in the Gulf region is of short duration and that the global political situation calms down afterwards, dampening factors from the Iraq conflict are expected to wane. Impulses from expansionary monetary policy will then increasingly take effect and domestic driving forces will gain the upper hand. We expect real GDP to increase by 1.0 percent and by 2.6 percent in 2003 and 2004, respectively. The situation on the labor market will start to improve towards the end of this year only. Inflation will be moderate over the forecast horizon. In 2004, consumer prices will probably rise by 1.9 percent on average, after 2.2 percent this year. --