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

  • Bokan, Nikola
  • Hughes Hallett, Andrew

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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Paper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2007-42.

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Date of creation: 2007
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Handle: RePEc:zbw:ifwedp:6169
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  1. Tamim Bayoumi & Douglas Laxton & Paolo Pesenti, 2004. "Benefits and spillovers of greater competition in Europe: a macroeconomic assessment," Staff Reports 182, Federal Reserve Bank of New York.
  2. Ravn, Morten O & Schmitt-Grohé, Stephanie & Uribe, Martín, 2005. "The Macroeconomics of Subsistence Points," CEPR Discussion Papers 4843, C.E.P.R. Discussion Papers.
  3. Masao Ogaki & Carmen M. Reinhart, 1998. "Measuring Intertemporal Substitution: The Role of Durable Goods," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 1078-1098, October.
  4. Galí, Jordi & López-Salido, David & Vallés, Javier, 2004. "Understanding the effects of government spending on consumption," Working Paper Series 0339, European Central Bank.
  5. Edward C. Prescott, 2004. "Why Do Americans Work So Much More Than Europeans?," Levine's Bibliography 122247000000000413, UCLA Department of Economics.
  6. Dellas, Harris & Tavlas, George, 2003. "Wage Rigidity and Monetary Union," CEPR Discussion Papers 3679, C.E.P.R. Discussion Papers.
  7. 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.
  8. 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).
  9. Reinhart, Carmen & Ogaki, Masao, 1998. "Intertemporal substitution and durable goods: long-run data," MPRA Paper 13683, University Library of Munich, Germany.
  10. Spector, David, 2004. "Competition and the capital-labor conflict," European Economic Review, Elsevier, vol. 48(1), pages 25-38, February.
  11. 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.
  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, vol. 19(2), pages 229-250, June.
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