Macroeconomic Policy Lessons of Labour Market Frictions

This Paper explores the consequences of macroeconomic policy for labour market outcomes in the presence of frictions. It shows how policy may be useful in overriding frictions, as well as how it might generate adverse outcomes. The analysis looks at the main tools of macroeconomic policy and pertains to both the steady state and business cycle fluctuations. A partial-equilibrium, empirically-grounded model is used to simulate policy effects. It relies on a reduced-form VAR of the actual data to specify the effect of exogenous variables, precluding the possibility that labour market results will be affected by misspecifications in other parts of a more general macroeconomic model. The Paper shows how policy affects the natural rate of unemployment and other key outcomes, such as unemployment duration, wages, and the asset value of the job-worker match. Effects on the persistence, co-movement and volatility of the major variables along the business cycle are discussed, demonstrating how policy affects rigidity in the labour market.