Macroeconomic Fluctuations and Microeconomic Adjustments : Wages, Capital, and Labor market Policy

University dissertation from Uppsala : Nationalekonomiska institutionen

Abstract: Essay 1 (with Henrik Jordahl) investigates how the degree of central bank conservatism affects the government's incentives to reform the labor market. An increase in conservatism triggers two opposite effects. It reduces the inflation bias of discretionary monetary policy and hence the benefits of a reform. It also increases unemployment variability, which increases the precautionary benefits of a reform. In combination, the two effects produce a unshaped relation between conservatism and labor market reform. To test this prediction, we use data for 19 OECD countries for the period 1980-1994. Our proxies for reform are unemployment, different labor market institutions and indices of labor market rigidities. Conservatism is proxied by two common measures of central bank independence. We find support for the prediction of a u-shaped relation between conservatism and labor market reform. Essay 2 investigates to what extent firm-specific uncertainty affects the gain from indexation. Gottfries (1992) tried to explain wage rigidity by arguing that, given wages, the price level is fairly predictable, and insiders face little layoff risk due to employment fluctuations caused by aggregate shocks. But the assumption that aggregate shocks are the main determinants of employment fluctuations seems hard to reconcile with the recent literature on job creation and job destruction. In this paper I examine how firm- specific shocks affect the gain from writing state contingent wage contracts. By numerically solving an insider-outsider model I show that the introduction of firm-specific uncertainty increases the gain from indexation considerably for indexation to aggregate demand (from 0 to 1.5 percent of the wage) but only slightly for indexation to the price level or productivity (from 0.016 to 0.6 percent of the wage). The analysis suggests that nominal wage contracts should be more prevalent when layoff is not so costly for the worker, e.g. due to high unemployment benefits or short duration of unemployment spells. Essay 3 investigates whether renegotiation is an alternative to indexation of labor contracts. More specifically I investigate how renegotiation caused by firm-specific shocks affects the gain from indexation to aggregate uncertainty. If wage contracts are incomplete some unforeseen events may occur for which provisions have not been made in the contract. In such a situation the contracting parties may want to renegotiate. It is shown that the gain from indexation decreases by as much as fifty percent when the option to renegotiate the contract is introduced. Renegotiation can therefore be an alternative, albeit imperfect, to indexation. Both the gain from indexation as such and the effect of renegotiation on the gain depends crucially on the job security of the workers. Increased job security increases the gain from indexation but this increase is mitigated by the possibility to renegotiate the contract. Essay 4 (with Mikael Carlsson) examines the capital adjustment process in Swedish manufacturing firms and relates the empirical findings to standard models of firm behavior in the presence of impediments to capital adjustments. We find that (i) a model with irreversible capital goes a very long way in capturing the salient features of firm-level capital adjustment behavior. To see this an integrated approach is necessary since different alternative models do well in certain comparative dimensions but not in others. (ii) The partial adjustment model generally fails to explain capital adjustment patterns. (iii) The capital accumulation process is a highly volatile and non-persistent process on the firm-level. (iv) Firms adjustment behavior is asymmetric in that they are more likely to tolerate excess capital than shortages of capital, and finally, (v) the estimated adjustment function implies that aggregate investment is relatively unresponsive to aggregate variables (interest rates etc.) in deep recessions as compared to the responsiveness in normal times.

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