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The Impact of Tax, Product and Labour Market Distortions on the Phillips Curve and the Natural Rate of Unemployment

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  • Nikola Bokan
  • Andrew Hughes Hallett

Abstract

Most people accept that structural and labour market reforms are needed in Europe. However few have been undertaken. The usual conjecture is that reforms are costly in economic performance and costly to finance. Blanchard and Giavazzi (2003) and Spector (2004) develop a general equilibrium model with imperfect competition to show the impact of labour or product market deregulation. We extend that model to combine both reforms, and include the costs of financing them, the conflict between long run gains and short run costs, and to allow for reforms of distortionary taxation. We also extend the model to explain the natural rate of unemployment and non-wage employment costs, to show the impact of reform on the short and long run Phillips curve parameters. We find that structural reforms imply short run costs but long run gains (unemployment rises and then falls, while wages move in the opposite way); that the long run gains outweigh the short run costs; and that the financing of such reforms is the main stumbling block. We also find that the implications for welfare improvements and employment generation are quite different: tax reforms are more effective for welfare, but market liberalisation for employment.

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1336.

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Length: 27 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:kie:kieliw:1336

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Keywords: Structural reform; wage bargains; short vs. long run substitutability; endogenous entry of firms;

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  1. Richard Rogerson & Robert Shimer & Randall Wright, 2004. "Search-Theoretic Models of the Labor Market-A Survey," NBER Working Papers 10655, National Bureau of Economic Research, Inc.
  2. Galí, Jordi & López-Salido, David & Vallés, Javier, 2004. "Understanding the effects of government spending on consumption," Working Paper Series, European Central Bank 0339, European Central Bank.
  3. Bayoumi, Tamim & Laxton, Douglas & Pesenti, Paolo, 2004. "Benefits and spillovers of greater competition in Europe: a macroeconomic assessment," Working Paper Series, European Central Bank 0341, European Central Bank.
  4. Ravn, Morten O. & Schmitt-Grohé, Stephanie & Uribe, Martín, 2005. "The Macroeconomics of Subsistence Points," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4843, C.E.P.R. Discussion Papers.
  5. Spector, David, 2004. "Competition and the capital-labor conflict," European Economic Review, Elsevier, Elsevier, vol. 48(1), pages 25-38, February.
  6. Harris Dellas & George Tavlas, 2002. "Wage Rigidity and Monetary Union," Diskussionsschriften, Universitaet Bern, Departement Volkswirtschaft dp0219, Universitaet Bern, Departement Volkswirtschaft.
  7. Ogaki, Masao & Reinhart, Carmen M., 1998. "Intertemporal substitution and durable goods: long-run data," Economics Letters, Elsevier, Elsevier, vol. 61(1), pages 85-90, October.
  8. John V. Duca & David D. VanHoose, 2000. "Has Greater Competition Restrained U.S. Inflation?," Southern Economic Journal, Southern Economic Association, vol. 66(3), pages 729=741, January.
  9. Edward C. Prescott, 2004. "Why do Americans Work so Much More than Europeans?," NBER Working Papers 10316, National Bureau of Economic Research, Inc.
  10. Masao Ogaki & Carmen M. Reinhart, 1998. "Measuring Intertemporal Substitution: The Role of Durable Goods," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 106(5), pages 1078-1098, October.
  11. Galí, Jordi & Vallés, Javier & Wolman, Alexander L., 2003. "Understanding the effects of government spending on consumption," CFS Working Paper Series 2004/23, Center for Financial Studies (CFS).
  12. Hallett, Andrew Hughes & Jensen, Svend E. Hougaard & Richter, Christian, 2005. "The European economy at the cross roads: Structural reforms, fiscal constraints, and the Lisbon Agenda," Research in International Business and Finance, Elsevier, Elsevier, vol. 19(2), pages 229-250, June.
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Cited by:
  1. Andrew Hughes Hallett, 2008. "Sustainable fiscal policies and budgetary risk under alternative monetary policy arrangements," Economic Change and Restructuring, Springer, Springer, vol. 41(1), pages 1-28, March.
  2. Andrew Hughes Hallett, 2008. "Coordination without Explicit Cooperation: Monetary-Fiscal Interactions in an Era of Demographic Change," European Economy - Economic Papers, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission 305, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.

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