Macroeconomic Effects of Reducing Labour Tax in the Euro Area. A Structural Model-Based Approach (12 th Dynare Conference , Rome 2016) Pascal Jacquinot 1 Matija Lozej 2 Massimiliano Pisani 3 1 European Central Bank 2 Central Bank of Ireland 3 Banca d’Italia PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 1 / 26
Disclaimer The views presented here are the views of the authors and do not necessarily reflect the views of their respective institutions, or of the Eurosystem. Results are preliminary. PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 2 / 26
Introduction Motivation ”...there is leeway to achieve a more growth-friendly composition of fiscal policies. As a start, it should be possible to lower the tax burden in a budget-neutral way.” Mario Draghi (From Unemployment in the euro area, Speech by Mario Draghi, President of the ECB, Annual central bank symposium in Jackson Hole, 22 August 2014) PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 3 / 26
Introduction Motivation It would be desirable to have tools that enables the analysis of fiscal policies on (un)employment in a monetary union. No micro-founded involuntary unemployment in the baseline EAGLE No public sector production or public sector employment ⇒ No ability to analyse: Effects of fiscal policies in a setting with frictional labour market: Tax or spending changes Changes in public sector employment or compensation Feedback effects from unemployment on government budget Effects of labour mobility between sectors Interaction of fiscal policies with labour market frictions PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 4 / 26
Introduction What is new To address the above issues, we introduce: 1 Frictional labour market with unemployment 2 Combine labour market frictions with taxation 3 Add the public sector with non-negligible employment 4 Directed search to account for links between private and public sectors through the labour market Note: Links between private and public-sector labour markets have been investigated empirically (e.g., Lane and Perotti, 2003; Lamo et al., 2013a, 2013b, etc.) and in structural models (Quadrini and Trigari, 2007; St¨ ahler and Thomas, 2013; Afonso and Gomes, 2014, etc.) PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 5 / 26
Introduction Afonso and Gomes (2010) PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 6 / 26
Frictional labour market with taxation Setup Basic model A continuum of labour firms post vacancies, sell labour services to intermediate goods firms at competitive prices New matches become productive immediately, break-ups occur in the beginning of the period, newly unemployed search within the period and, if matched, become productive immediately Labour firms bargain with households to determine wages and hours Unemployment benefits are distributed by the government Labour taxes are paid by labour firms Full model Government sets wages and employment (vacancies) unilaterally in the public sector Public sector can have a wage premium Unemployed at the beginning of the period can direct their search to private or public sector PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 7 / 26
Frictional labour market with taxation Matching Matching I Matching function M s t gives the number of matches in sector s , where s ∈ { P , G } , with P denoting private and G public sector (there is no G -sector in the basic model) The number of vacancies in a sector is vac s t , un s t is the number of searching workers in a sector Parameter φ s mat is the efficiency of the matching process and µ s mat determines the elasticity mat un s µ s vac s 1 − µ s M s t = φ s mat mat , t t PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 8 / 26
Frictional labour market with taxation Matching Matching II The probability for a worker to find a job in sector s , p s , W , is: � 1 − µ s � vac s mat p s , W = M s t / un s t = φ s t , t mat un s t and the probability for a firm in sector s to find a worker, p s , F is: � − µ s � vac s mat p s , F = M s t / vac s t = φ s t . t mat un s t PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 9 / 26
Frictional labour market with taxation Matching Value functions of a worker A worker can be either employed or unemployed, in which case he/she searches for a job. Value functions are defined per worker and immediately after matching has been completed. Value of being employed h s 1+ ζ t − χ E s t = (1 − τ wh ) w s t h s t 1 + ζ + t λ t + β λ t +1 � � x (1 − p s , W x (1 − p s , W δ s t +1 ) U s t +1 + (1 − δ s t +1 )) E s t +1 λ t Value of being unemployed ( u ben denotes unemployment benefits) t = u ben , t + β λ t +1 � � U s p s , W t +1 E s t +1 + (1 − p s , W t +1 ) U s t +1 λ t PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 10 / 26
Frictional labour market with taxation Matching Value functions of a firm Each labour firm sells labour services to the intermediate goods firm at the price x t , pays a wage w s t , labour taxes τ wf , and pays a per-period cost of t having a vacancy open ψ . A hired worker works h s t hours, which are transformed into labour services: y s , h = h s α H , where α H < 1. t t Value of having a worker t + β λ t +1 t = x t h s α H J s − (1 + τ wf ) w s t h s J s � � (1 − δ x ) t t t +1 λ t Value of having a vacancy t + β λ t +1 � � t = − ψ + p s , F (1 − p s , F V s J s ) V s t t t +1 λ t PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 11 / 26
Frictional labour market with taxation Matching Free entry Firms will enter (= post vacancies) as long as the value of having a vacancy > 0. In equilibrium, this will stop when V s t = 0. This implies: ψ = p s , F J s , t t This equation determines the number of vacancies posted. Note that in the public sector , value functions are not required (but they do exist and are analogous to those in the private sector) as long as government sets wages and determines the number of vacancies. PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 12 / 26
Frictional labour market with taxation Wages and hours in the private sector Wages and hours in the private sector Wages are determined using Nash bargaining implicitly by: η (1 − τ wh ) J P , t = (1 − η )(1 + τ wf ) ( E P , t − U P , t ) t t Hours in the private sector are determined as: = χ h P ζ (1 + τ wf ) α H x t h P , α H − 1 t t t λ t (1 − τ wh ) t PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 13 / 26
Public sector Public sector employment and wages Public sector employment and wages Government sets public sector vacancies as: t = (1 − ρ vac ) vac G + ρ vac vac G vac G t − 1 + ε t , vac Public sector wages, w G , are set by the government at a premium, pr , over what labour firms charge to intermediate goods firms in the private sector in the steady state, x : w G , t = pr t x Hours in the public sector are determined as: = χ h G ζ (1 + τ wf ) α H xh G , α H − 1 t t t λ t (1 − τ wh ) t PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 14 / 26
Labour market linkages Directed search Searching workers can decide in which sector they wish to search In equilibrium, the value of searching has to be the same in both sectors Workers take into account that by switching sectors they can get either employed in that sector or unemployed (1 − p G , W t + p G , W t = (1 − p P , W t + p P , W ) U G E G ) U P E P t t t t t PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 15 / 26
Calibration Calibration We set p G , F = p P , F = p P , W = 0 . 7, h = 1, unemployment, public-sector employment share, and wage premium to obtain: Parameter Home REA US RW Matching efficiency, private, φ P 0.7 0.7 0.7 0.7 mat Matching efficiency, public, φ G 0.441 0.441 0.525 0.489 mat Vacancy posting cost, ψ 0.12 0.12 0.55 0.55 Break-up rate, private, δ P 0.052 0.049 0.043 0.040 x Disutility of labour, χ 2.246 2.245 2.777 2.717 Job finding prob. in pub. s., p P , W 0.07 0.07 0.17 0.12 Matching elasticity, private, µ P 0.5 0.5 0.5 0.5 mat Matching elasticity, public, µ G 0.2 0.2 0.2 0.2 mat Replacement ratio, rr 0.5 0.5 0.2 0.2 Labour supply elasticity, ζ 0.5 0.5 0.5 0.5 Public sector wage premium 3% 3% 3% 5% Public sector empl. share 12.8% 18.5% 17% 15% Unemployment rate 0.08 0.08 0.06 0.06 PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 16 / 26
Fiscal policies and the labour market Fiscal policies and the labour market The following fiscal policy measures are considered: 1 Permanent reduction in labour taxes payable by households ... in Home ... in Basic model ... in Full model 2 Permanent reduction in labour taxes payable by firms ... in Home ... in Basic model ... in Full model 3 All shocks are standardised to 1 p.p. GDP ex-ante, amounting to approx. 1.8 p.p. change in the tax rates PJ, ML, MP (ECB, CBIE, BdI) Labour EAGLE September 2016 17 / 26
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