Migration and Business Cycle Dynamics

We examine the business cycle effects that arise from an expansion of the population due to migration. We identify the contribution that migration shocks make to cyclical fluctuations, and illustrate their dynamic impact. The analysis presented here is conducted in per capita terms. We develop a dynamic stochastic general equilibrium (DSGE) model to explore the consequences of migration. Households consume foreign- and domestically-produced goods, and housing. Domestically-produced goods are produced using effective labour and physical capital, where effective labour is a composite of physical labour and human capital. The level of human capital is particularly important for the dynamics of the migration shock as it amplifies the labour supply impact of a migration impulse. The model also embodies other frictions. Physical capital, for example, has a variable utilisation rate and adjusting the stock of capital is costly. Variable utilisation and capital adjustment costs are important for the dynamics of shocks. Variable utilisation provides an extra margin of adjustment in response to a shock, while capital adjustment costs serve to slow the propagation of shocks to investment. The model has three stocks of capital: physical capital; housing; and human capital. A migration inflow erodes the per capita stock of physical and housing capital, but the effect on the stock of human capital is ambiguous because migrants may have more or less human capital than domestic residents. The stock of migrant human capital relative to local resident human capital has a material impact on the dynamics of the migration impulse and on the contribution that migrant shocks make to business cycle fluctuations. Using the estimated DSGE model, we show that migration shocks account for a considerable portion of the variability of per capita gross domestic product (GDP). While migration shocks matter for the capital investment and consumption components of per capita GDP, there are other drivers of cyclical fluctuations in these expenditure components that are even more important. Migration shocks also matter for residential investment and real house prices, but once again other shocks play a larger role in driving volatility. In the DSGE model, the level of human capital possessed by migrants relative to that of locals materially affects the business cycle impact of migration. The impact of migration shocks is larger when migrants have substantially different – larger or smaller – levels of human capital relative to locals. When the average migrant has higher levels of human capital than locals, as seems to be common in most OECD economies, a migration shock has an expansionary effect on per capita GDP and its components, which also accords with the evidence from a restricted structural vector autoregression.