An estimated Dynamic Stochastic Disequilibrium model of Euro-Area unemployment

An empirical variant of the Dynamic Stochastic Disequilibrium (DSDE) model proposed by Schoder (2017a) is estimated for the Euro Area using Bayesian inference. Unemployment arises from job rationing due to insufficient aggregate spending. The nominal wage is taken as a policy variable subject to a collective Nash bargaining process between workers and firms with the state of the labor market affecting the relative bargaining power. A consumption function is implied by a precautionary saving motive arising from an uninsurable risk of permanent income loss. Comparing the estimated DSDE model to the corresponding estimated Dynamic Stochastic General Equilibrium (DSGE) model with frictional unemployment yields the following results: (i ) the DSDE model outperforms the corresponding DSGE model empirically according to the Bayes factor. (ii ) The fiscal multiplier is considerably higher in the DSDE model than in the DSGE model. (iii ) As observed empirically, the DSDE model predicts the real wage to move pro-cyclically with a lag whereas the DSGE model predicts a counter-cyclical movement. (iv ) In the DSDE model, a productivity shock is contractionary in the short run and expansionary in the medium run. (v) Strengthening the worker's bargaining power is expansionary in the short run and contractionary in the medium run. (vi ) Output variation is mainly driven by demand shocks in the DSDE model. Productivity shocks are important only in the DSGE model. (vii ) Unemployment variation is primarily caused by demand and productivity shocks in the DSDE model. Labor supply shocks are essential only in the DSGE model.