Labor force participation, wage rigidities, and inflation Francesco Nucci* and Marianna Riggi** *Sapienza University of Rome ** Bank of Italy Challenges for macroeconomic policy in a low inflation environment ECB 5-6 November 2015 Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Motivation LFP ECB, Economic Bulletin, 1-2015 "Despite the severe recessionary periods that have affected the euro area in recent years, the labour force participation rate in the euro area has shown atypically positive developments." Labor force participation rate, Aged 15-64 104 euro area US 102 100 98 96 2008 2010 2012 2014 US, OECD; euro area: Labor Force Survey (Eurostat). Euro area data refer to the EA-18 aggregate Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Motivation Y����� (2014): "...the key question is: What portion of the decline in LFP reflects structural shifts and what portion reflects cyclical weakness in the labor market? [...] the pace of the decline (in LFP) accelerated with the recession [...] greater worker discouragement is most directly the result of a weak labor market ... The interaction of labor force participation and inflationary pressures has been understudied " Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Motivation Y����� (2014): "...the key question is: What portion of the decline in LFP reflects structural shifts and what portion reflects cyclical weakness in the labor market? [...] the pace of the decline (in LFP) accelerated with the recession [...] greater worker discouragement is most directly the result of a weak labor market ... The interaction of labor force participation and inflationary pressures has been understudied " E���� ��� L���� (2014): "Our paper provides compelling evidence that cyclical factors account for the bulk of the recent decline in the LFP rate " Similar results in Van Zandweghe 2012; Hotchkiss and Rios-Avila 2013, among others. Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Our paper We document that, beyond the continuation of structural, long run developments, a 1 part of the post- crisis increase in the euro area LFP is attributable to cyclical factors. Procyclical LFP in the US versus countercyclical LFP in the euro area. Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Our paper We document that, beyond the continuation of structural, long run developments, a 1 part of the post- crisis increase in the euro area LFP is attributable to cyclical factors. Procyclical LFP in the US versus countercyclical LFP in the euro area. We provide a structural interpretation of these diverging paths by developing a 2 theoretical general equilibrium model Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Our paper We document that, beyond the continuation of structural, long run developments, a 1 part of the post- crisis increase in the euro area LFP is attributable to cyclical factors. Procyclical LFP in the US versus countercyclical LFP in the euro area. We provide a structural interpretation of these diverging paths by developing a 2 theoretical general equilibrium model Higher real wage rigidities and/or habit in consumers’ preferences can make the LFP countercyclical Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Our paper We document that, beyond the continuation of structural, long run developments, a 1 part of the post- crisis increase in the euro area LFP is attributable to cyclical factors. Procyclical LFP in the US versus countercyclical LFP in the euro area. We provide a structural interpretation of these diverging paths by developing a 2 theoretical general equilibrium model Higher real wage rigidities and/or habit in consumers’ preferences can make the LFP countercyclical Through our model, we shed light on some implications of labor force cyclicality for 3 inflation Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Our paper We document that, beyond the continuation of structural, long run developments, a 1 part of the post- crisis increase in the euro area LFP is attributable to cyclical factors. Procyclical LFP in the US versus countercyclical LFP in the euro area. We provide a structural interpretation of these diverging paths by developing a 2 theoretical general equilibrium model Higher real wage rigidities and/or habit in consumers’ preferences can make the LFP countercyclical Through our model, we shed light on some implications of labor force cyclicality for 3 inflation Irrelevance of real wage rigidities for inflation Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Labor force cyclicality in the euro area Rolling Correlations between hp-filtered LFP and gdp growth in the euro area 0.5 0 -0.5 -1 2000 2002 2004 2006 2008 2010 2012 2014 Correlations are calculated in a 3-year rolling window of quarterly data LFP rate refers to the working age population (15-64) Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Labor force cyclicality in the euro area hp-filtered LFP Post 2008 Post 2000 − 0 . 010 − 0 . 027 Constant ( 0 . 036 ) ( 0 . 029 ) GDP t − GDP t − 1 − 0 . 088 ∗∗ −− GDP t − 1 ( 0 . 043 ) GDP t − GDP t − 1 ∗ D _ pre _ 2008 −− − 0 . 090 GDP t − 1 ( 0 . 062 ) GDP t − GDP t − 1 − 0 . 090 ∗∗ ∗ D _ post _ 2008 −− GDP t − 1 ( 0 . 041 ) ∗∗ significance at the 5 per cent level. Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Labor force cyclicality in the euro area Panel regression Post 2008 hp-filtered LFP − 0 . 015 Constant ( 0 . 031 ) GDP it − GDP it − 1 − 0 . 048 ∗∗ GDP it − 1 ( 0 . 020 ) ∗∗ significance at the 5 per cent level. Panel regression on euro area countries, where we control for cross-country heterogeneity by allowing for time-invariant, country-specific fixed effects in the estimation. Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Labor force cyclicality in the euro area The increase in the labor force participation rate has been larger in those euro area countries that have been hit the hardest by the crisis euro area 19 Notes: on the horizontal axis, we consider the difference between the lowest and the highest value of real GDP attained by each country in the post-2007 period. In the vertical axis the overall change in the LFP rate over the post-2007 period is considered. Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Our theoretical model Nominal price rigidities à la Calvo and search and matching frictions in the labor market à la Diamond-Mortensen-Pissarides Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Our theoretical model Nominal price rigidities à la Calvo and search and matching frictions in the labor market à la Diamond-Mortensen-Pissarides What is new: Standard business cycle models ignore the participation margin. In our model household’s labor supply choices include how many family members should participate in the market work, rather than contribute to home labor. Family members can be employed, unemployed (and searching for a job), or out of the labor force Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
Our theoretical model Nominal price rigidities à la Calvo and search and matching frictions in the labor market à la Diamond-Mortensen-Pissarides What is new: Standard business cycle models ignore the participation margin. In our model household’s labor supply choices include how many family members should participate in the market work, rather than contribute to home labor. Family members can be employed, unemployed (and searching for a job), or out of the labor force We follow Campolmi and Gnocchi (2014) in modeling labor market flows Challenges for macroeconomic policy in a low inflation *Sapienza ** Bank of Italy F. Nucci and M. Riggi ... (*Sapienza University of Rome ** Bank of Italy) / 33
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