IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/14886.html
   My bibliography  Save this paper

Insider-Outsider Labor Markets, Hysteresis and Monetary Policy

Author

Listed:
  • Galí, Jordi

Abstract

I develop a version of the New Keynesian model with insider-outsider labor markets and hysteresis that can account for the high persistence of European unemployment. I study the implications of that environment for the design of monetary policy. The optimal policy calls for strong emphasis on (un)employment stabilization which a standard interest rate rule fails to deliver, with the gap between the two increasing in the degree of hysteresis. Two simple targetiing rules are shown to approximate well the optimal policy. The properties of the model and effects of different policies are analyzed through the lens of the labor wedge and its components.

Suggested Citation

  • Galí, Jordi, 2020. "Insider-Outsider Labor Markets, Hysteresis and Monetary Policy," CEPR Discussion Papers 14886, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:14886
    as

    Download full text from publisher

    File URL: https://cepr.org/publications/DP14886
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. David Friedman, 1999. "Why Not Hang Them All: The Virtues of Inefficient Punishment," Journal of Political Economy, University of Chicago Press, vol. 107(S6), pages 259-269, December.
    2. Olivier Blanchard, 2018. "Should We Reject the Natural Rate Hypothesis?," Journal of Economic Perspectives, American Economic Association, vol. 32(1), pages 97-120, Winter.
    3. Chugh, Sanjay K. & Lechthaler, Wolfgang & Merkl, Christian, 2018. "Optimal fiscal policy with labor selection," Journal of Economic Dynamics and Control, Elsevier, vol. 94(C), pages 142-189.
    4. Jordi Galí & Mark Gertler & J. David López-Salido, 2007. "Markups, Gaps, and the Welfare Costs of Business Fluctuations," The Review of Economics and Statistics, MIT Press, vol. 89(1), pages 44-59, November.
    5. Robert J. Gordon, 1997. "The Time-Varying NAIRU and Its Implications for Economic Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 11-32, Winter.
    6. Gary S. Becker, 1974. "Crime and Punishment: An Economic Approach," NBER Chapters, in: Essays in the Economics of Crime and Punishment, pages 1-54, National Bureau of Economic Research, Inc.
    7. Jordi Galí & Frank Smets & Rafael Wouters, 2012. "Unemployment in an Estimated New Keynesian Model," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 329-360.
    8. Warne, Anders & Coenen, Günter & Christoffel, Kai, 2008. "The new area-wide model of the euro area: a micro-founded open-economy model for forecasting and policy analysis," Working Paper Series 944, European Central Bank.
    9. Loukas Karabarbounis, 2014. "The Labor Wedge: MRS vs. MPN," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(2), pages 206-223, April.
    10. Hall, Robert E, 1997. "Macroeconomic Fluctuations and the Allocation of Time," Journal of Labor Economics, University of Chicago Press, vol. 15(1), pages 223-250, January.
    11. Robert Shimer, 2009. "Convergence in Macroeconomics: The Labor Wedge," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 280-297, January.
    12. Jordi Galí, 2015. "Hysteresis and the European Unemployment Problem Revisited," NBER Working Papers 21430, National Bureau of Economic Research, Inc.
    13. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2007. "Business Cycle Accounting," Econometrica, Econometric Society, vol. 75(3), pages 781-836, May.
    14. Luis J. Álvarez & Emmanuel Dhyne & Marco Hoeberichts & Claudia Kwapil & Hervé Le Bihan & Patrick Lünnemann & Fernando Martins & Roberto Sabbatini & Harald Stahl & Philip Vermeulen & Jouko Vilmunen, 2006. "Sticky Prices in the Euro Area: A Summary of New Micro-Evidence," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 575-584, 04-05.
    15. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," NBER Chapters, in: NBER Macroeconomics Annual 1986, Volume 1, pages 15-90, National Bureau of Economic Research, Inc.
    16. Douglas Staiger & James H. Stock & Mark W. Watson, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter.
    17. Roger E. A. Farmer, 2015. "The Stock Market Crash Really Did Cause the Great Recession," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 77(5), pages 617-633, October.
    18. Olivier Coibion & Yuriy Gorodnichenko & Mauricio Ulate, 2018. "The Cyclical Sensitivity in Estimates of Potential Output," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 49(2 (Fall)), pages 343-441.
    19. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    20. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 123(4), pages 1415-1464.
    21. Gottfries, Nils & Horn, Henrik, 1987. "Wage Formation and the Persistence of Unemployment," Economic Journal, Royal Economic Society, vol. 97(388), pages 877-884, December.
    22. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
    23. A. W. Phillips, 1958. "The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861–1957," Economica, London School of Economics and Political Science, vol. 25(100), pages 283-299, November.
    24. Laurence Ball, 2014. "Long-term damage from the Great Recession in OECD countries," European Journal of Economics and Economic Policies: Intervention, Edward Elgar Publishing, vol. 11(2), pages 149-160, September.
    25. Blanchard, Olivier J. & Summers, Lawrence H., 1987. "Hysteresis in unemployment," European Economic Review, Elsevier, vol. 31(1-2), pages 288-295.
    26. David Cutler & Grant Miller, 2005. "The role of public health improvements in health advances: The twentieth-century United States," Demography, Springer;Population Association of America (PAA), vol. 42(1), pages 1-22, February.
    27. Barnichon, Regis, 2010. "Productivity and unemployment over the business cycle," Journal of Monetary Economics, Elsevier, vol. 57(8), pages 1013-1025, November.
    28. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Laurence Ball & Joern Onken, 2022. "Hysteresis in unemployment: Evidence from OECD estimates of the natural rate," International Finance, Wiley Blackwell, vol. 25(3), pages 268-284, December.
    2. Marco Guerrazzi, 2020. "Wage and employment determination in a dynamic insider–outsider model," Evolutionary and Institutional Economics Review, Springer, vol. 17(1), pages 1-23, January.
    3. Wolfgang Lechthaler & Mewael F. Tesfaselassie, 2023. "Endogenous Growth, Skill Obsolescence, and Output Hysteresis in a New Keynesian Model with Unemployment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(8), pages 2187-2213, December.
    4. Daniel S. Grossman & Brad R. Humphreys & Jane E. Ruseski, 2019. "Out of the outhouse: The impact of place‐based policies on dwelling characteristics in Appalachia," Journal of Regional Science, Wiley Blackwell, vol. 59(1), pages 5-28, January.
    5. Olivier J. Blanchard, 2017. "Should we Get rid of the Natural Rate Hypothesis?," NBER Working Papers 24057, National Bureau of Economic Research, Inc.
    6. repec:aeb:wpaper:201604:i:4:y:2016 is not listed on IDEAS
    7. Edward L. Glaeser & Wentao Xiong, 2017. "Urban Productivity in the Developing World," NBER Working Papers 23279, National Bureau of Economic Research, Inc.
    8. Bennett, Daniel L. & Faria, Hugo J. & Gwartney, James D. & Morales, Daniel R., 2017. "Economic Institutions and Comparative Economic Development: A Post-Colonial Perspective," World Development, Elsevier, vol. 96(C), pages 503-519.
    9. Hegelund, Erik & Taalbi, Josef, 2023. "What determines unemployment in the long run? Band spectrum regression on ten countries 1913–2016," Structural Change and Economic Dynamics, Elsevier, vol. 64(C), pages 144-167.
    10. Antonio Estache, 2016. "Institutions for Infrastructure in Developing Countries: What We Know and the Lot We still Need to Know," Working Papers ECARES ECARES 2016-27, ULB -- Universite Libre de Bruxelles.
    11. George Alogoskoufis, 2018. "The Clash of Central Bankers with Labour Market Insiders, and the Persistence of Inflation and Unemployment," Economica, London School of Economics and Political Science, vol. 85(337), pages 152-176, January.
    12. George Alogoskoufis, 2016. "Unemployment Persistence, Inflation and Monetary Policy in A Dynamic Stochastic Model of the Phillips Curve," Working Papers 201604, Athens University Of Economics and Business, Department of Economics.
    13. Váry, Miklós, 2021. "The long-run real effects of monetary shocks: Lessons from a hybrid post-Keynesian-DSGE-agent-based menu cost model," Economic Modelling, Elsevier, vol. 105(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Jordi Galí, 2022. "Insider–Outsider Labor Markets, Hysteresis, and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 54(S1), pages 53-88, February.
    2. Jordi Galí, 2015. "Hysteresis and the European unemployment problem revisited," Economics Working Papers 1488, Department of Economics and Business, Universitat Pompeu Fabra.
    3. Jordi Galí, 2011. "The Return Of The Wage Phillips Curve," Journal of the European Economic Association, European Economic Association, vol. 9(3), pages 436-461, June.
    4. Jordi Galí & Frank Smets & Rafael Wouters, 2012. "Unemployment in an Estimated New Keynesian Model," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 329-360.
    5. Garga, Vaishali & Singh, Sanjay R., 2021. "Output hysteresis and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 871-886.
    6. Brand, Claus & Obstbaum, Meri & Coenen, Günter & Sondermann, David & Lydon, Reamonn & Ajevskis, Viktors & Hammermann, Felix & Angino, Siria & Hernborg, Nils & Basso, Henrique & Hertweck, Matthias & Bi, 2021. "Employment and the conduct of monetary policy in the euro area," Occasional Paper Series 275, European Central Bank.
    7. Benjamin Born & Johannes Pfeifer, 2021. "Uncertainty‐driven business cycles: Assessing the markup channel," Quantitative Economics, Econometric Society, vol. 12(2), pages 587-623, May.
    8. Andrei Polbin & Sergey Drobyshevsky, 2014. "Developing a Dynamic Stochastic Model of General Equilibrium for the Russian Economy," Research Paper Series, Gaidar Institute for Economic Policy, issue 166P, pages 156-156.
    9. Oscar Jorda & Alan Taylor & Sanjay Singh, 2019. "The Long-Run Effects of Monetary Policy," 2019 Meeting Papers 1307, Society for Economic Dynamics.
    10. Igor Vetlov & Tibor Hlédik & Magnus Jonsson & Henrik Kucsera & Massimiliano Pisani, 2011. "Potential Output in DSGE Models," Bank of Lithuania Working Paper Series 9, Bank of Lithuania.
    11. Eijffinger, Sylvester C. W. & Grajales-Olarte, Anderson & Uras, Burak R., 2020. "Heterogeneity In Wage Setting Behavior In A New-Keynesian Model," Macroeconomic Dynamics, Cambridge University Press, vol. 24(6), pages 1512-1546, September.
    12. Sala, Luca & Söderström, Ulf & Trigari, Antonella, 2010. "The Output Gap, the Labor Wedge, and the Dynamic Behavior of Hours," CEPR Discussion Papers 8005, C.E.P.R. Discussion Papers.
    13. Fabian Eser & Peter Karadi & Philip R. Lane & Laura Moretti & Chiara Osbat, 2020. "The Phillips Curve at the ECB," Manchester School, University of Manchester, vol. 88(S1), pages 50-85, September.
    14. Farmer, Roger E.A., 2016. "The Evolution Of Endogenous Business Cycles," Macroeconomic Dynamics, Cambridge University Press, vol. 20(2), pages 544-557, March.
    15. Augustus J. Panton, 2020. "Climate hysteresis and monetary policy," CAMA Working Papers 2020-76, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    16. Skibińska, Małgorzata, 2016. "What drives the labour wedge? A comparison between CEE countries and the Euro Area," Economic Modelling, Elsevier, vol. 56(C), pages 148-161.
    17. Skibińska, Małgorzata, 2016. "What drives the labour wedge? A comparison between CEE countries and the Euro Area," Economic Modelling, Elsevier, vol. 56(C), pages 148-161.
    18. Alejandro Justiniano & Giorgio E. Primiceri & Andrea Tambalotti, 2013. "Is There a Trade-Off between Inflation and Output Stabilization?," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(2), pages 1-31, April.
    19. Pablo Burriel & Jesús Fernández-Villaverde & Juan Rubio-Ramírez, 2010. "MEDEA: a DSGE model for the Spanish economy," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 1(1), pages 175-243, March.
    20. Alok Johri & Muhebullah Karimzada, 2021. "Learning efficiency shocks, knowledge capital and the business cycle: A Bayesian evaluation," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 54(3), pages 1314-1360, November.

    More about this item

    Keywords

    Wage stickiness; New keynesian model; Unemployment fluctuations; Wage phillips curve; Monetary policy tradeoffs;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:14886. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://www.cepr.org .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.