Productivity Shock and Optimal Monetary Policy in a Unionized Labor Market. Forthcoming: The Manchester School

This paper presents a New Keynesian model characterized by labor indivisibilities, unemployment and a unionized labor market. The bargaining process between unions and firms introduces real wage rigidity and creates an endogenous trade-off between inflation and output stabilization. Under an optimal discretionary monetary policy a negative productivity shock requires an increase in the nominal interest rate. Moreover, an operational instrument rule will satisfy the Taylor principle, but will also require that the nominal interest rate does not necessarily respond one to one to an increase in the efficient rate of interest. The model calibration studies the response of the unionzed economy to productivity shocks under different monetary policy rules. Download Inf

We analyze, in this paper, a DSGE New Keynesian model with indi- visible labor where firms may belong to two different final goods producing sectors one where wages and employment are determined in competitive labor markets and the orther where wages and employment are the result of a contractual process between unions and firms. Bargaining between firms and monopoly unions implies real wage rigidity in the model and, in turn, an endogenous trade-off between output stabilization and infla- tion stabilization. We show that the negative effect of a productivity shock on inflation and the positive effect of a cost-push shock is crucially determined by the proportion of firms that belong to the competitive sec- tor. The larger is this number, the smaller are these effects. We derive a welfare based objective function as a second order Taylor approxima- tion of the expected utility of the economy's representative agent and we analyze optimal monetary policy. We show that the larger is the num- ber of firms that belong to the competitive sector, the smaller should be the response of the nominal interest rate to exogenous productivity and cost-push shocks. If we consider, however, an instrument rule where the interest rate must react to inflationary expectations, the rule is not af- fected by the structure of the labor market. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is larger than real wage volatility.

monetary policy

Productivity shocks and Optimal Monetary Policy in a Unionized Labor Market Economy

In this paper we analyze a general equilibrium dynamic stochastic New Keynesian model characterized by labor indivisibilities, unemployment and a unionized labor market. The presence of monopoly unions introduces real wage rigidities in the model. We show that as in Blanchard Galì (2005) the so called "divine coincidence" does not hold and a trade-off between inflation stabilization and the output stabilization arises. In particular, a productivity shock has a negative effect on inflation, while a reservation-wage shock has an effect of the same size but with the opposite sign. We derive a welfare-based objective function for the Central Bank as a second order Taylor approximation of the expected utility of the economy's representative household, and we analyze optimal monetary policy under discretion and under commitment. Under discretion a negative productivity shock and a positive exogenous wage shock will require an increase in the nominal interest rate. An operational instrument rule, in this case, will satisfy the Taylor principle, but will also require that the nominal interest rate does not necessarily respond one to one to an increase in the interest rate that supports the efficient equilibrium. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is relatively larger than real wage volatility.Optimal Monetary Policy, Monopolist Union, Labor Indivisibility

Productivity shocks and optimal monetary policy in a unionized labor market economy

In this paper we analyze a general equilibrium dynamic stochastic New Keynesian model characterized by labor indivisibilities, unemployment and a unionized labor market. The presence of monopoly unions introduces real wage rigidities in the model. We show that as in Blanchard Galì (2005) the so called "divine coincidence" does not hold and a trade-off between inflation stabilization and the output stabilization arises. In particular, a productivity shock has a negative effect on inflation, while a reservation-wage shock has an effect of the same size but with the opposite sign. We derive a welfare-based objective function for the Central Bank as a second order Taylor approximation of the expected utility of the economy's representative household, and we analyze optimal monetary policy under discretion and under commitment. Under discretion a negative productivity shock and a positive exogenous wage shock will require an increase in the nominal interest rate. An operational instrument rule, in this case, will satisfy the Taylor principle, but will also require that the nominal interest rate does not necessarily respond one to one to an increase in the efficient rate of interest. The model is calibrated under different monetary policy rules and under the optimal rule. We show that the correlation between productivity shocks and employment is strongly influenced by the monetary policy regime. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is relatively larger than real wage volatility.

Optimal monetary policy in economies with dual labor markets

We analyze, in this paper, a DSGE New Keynesian model with indivisible labor where firms may belong to two different final goods producing sectors: one where wages and employment are determined in competitive labor markets and the other where wages and employment are the result of a contractual process between unions and …rms. Bargaining between firms and monopoly unions implies real wage rigidity in the model and, in turn, an endogenous trade-o¤ between output stabilization and inflation stabilization. We show that the negative effect of a productivity shock on inflation and the positive effect of a cost-push shock is crucially determined by the proportion of firms that belong to the competitive sector. The larger is this number, the smaller are these effects. We derive a welfare based objective function as a second order Taylor approximation of the expected utility of the economy’s representative agent and we analyze optimal monetary policy. We show that the larger is the number of firms that belong to the competitive sector, the smaller should be the response of the nominal interest rate to exogenous productivity and cost-push shocks. If we consider, however, an instrument rule where the interest rate must react to inflationary expectations, the rule is not affected by the structure of the labor market. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is larger than real wage volatility.

Monetary Policy and Automatic Stabilizers: the Role of Progressive Taxation

We study the effects of progressive labor income taxation in an otherwise standard NK model. We show that progressive taxation (i) introduces a trade-off between output and inflation stabilization and affects the slope of the Phillips Curve; (ii) acts as automatic stabilizer changing the responses of the economy to technology shocks and demand shocks (iii) alters the prescription for the optimal discretionary interest rate rule. We also show that the welfare gains from commitment decrease as labor income taxes become more progressive. Quantitatively, the model is able to reproduce the observed negative correlation between the volatility of output, hours and in?ation and the degree of progressivity of labor income taxation.

Banking: a mechanism design approach

The authors study banking using the tools of mechanism design, without a priori assumptions about what banks are, who they are, or what they do. Given preferences, technologies, and certain frictions - including limited commitment and imperfect monitoring - they describe the set of incentive feasible allocations and interpret the outcomes in terms of institutions that resemble banks. The bankers in the authors' model endogenously accept deposits, and their liabilities help others in making payments. This activity is essential: if it were ruled out the set of feasible allocations would be inferior. The authors discuss how many and which agents play the role of bankers. For example, they show agents who are more connected to the market are better suited for this role since they have more to lose by reneging on obligations. The authors discuss some banking history and compare it with the predictions of their theory.Banks and banking

Cash-in-the-market pricing in a model with money and over-the-counter financial markets

Entrepreneurs need cash to finance their real investments. Since cash is costly to hold, entrepreneurs will underinvest. If entrepreneurs can access financial markets prior to learning about an investment opportunity, they can sell some of their less liquid assets for cash and, as a result, invest at a higher level. When financial markets are over-the-counter, the price that the entrepreneur receives for the assets that he sells depends on the amount of liquidity (cash) that is in the OTC market: Greater levels of liquidity lead to higher asset prices. Since asset prices are linked to liquidity, they can fluctuate over time even though asset fundamentals are fixed. Bid and ask prices naturally arise in an OTC market and the bid-ask spread is negatively correlated with asset returns when changes in asset prices are not related to changes in the OTC market structure. An increase in inflation widens bid-ask spreads and decreases asset price

Monetary Policy and Automatic Stabilizers: the Role of Progressive Taxation

We study the effects of progressive labor income taxation in an otherwise standard NK model. We show that progressive taxation (i) introduces a trade-off between output and inflation stabilization and affects the slope of the Phillips Curve; (ii) acts as automatic stabilizer changing the responses of the economy to technology shocks and demand shocks (iii) alters the prescription for the optimal discretionary interest rate rule. We also show that the welfare gains from commitment decrease as labor income taxes become more progressive. Quantitatively, the model is able to reproduce the observed negative correlation between the volatility of output, hours and in?ation and the degree of progressivity of labor income taxation