ÿlvaro Aguiar (CEMPRE-Faculdade de Economia do Porto) Ana Paula Ribeiro (CEMPRE-Faculdade de Economia do Porto)
Abstract
Lagged benefits relative to costs can politically block an efficiency-enhancing labor market reform, lending support to the "two-handed approach". An accommodating monetary policy, conducted alongside the reform, could help bringing the positive effects of the reform to the fore. In order to identify the mechanisms through which monetary policy may affect the political sustainability of a reform, we add stylized features of the labor market to a standard New-Keynesian model for monetary policy analysis. A labor market reform is modeled as a structural change inducing a permanent shift in the flexible-price unemployment and output levels. In addition to the permanent gains, the impact of the timing and magnitude of the reform-induced adjustments on the welfare of workers - employed and unemployed - is crucial to the political feasibility of the reform. Since the adjustments depend, on one hand, on the macroeconomic structure and, on the other hand, can be influenced by monetary policy, we simulate various degrees of output persistence across different policy rules. We find that, if inertia is present, monetary policy affects the political support for the reform. Choosing a particular policy rule, as well as the business cycle timing of the reform, are means to enhance political sustainability
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Find related papers by JEL classification: E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
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