Trend Productivity Growth and Labor Market Frictions in a New Keynesian Business Cycle Model

• Applicant: Professor Dennis Snower, Ph.D.
• Subject Area: Statistics and Econometrics
• Term: from 2012 to 2015
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 209667994

Until recently, most New Keynesian business cycle models used for monetary and fiscal policy analyses have ignored two empirically relevant features, namely, trend productivity growth and unemployment. Recent research has addressed the role of trend productivity growth and unemployment but only within two separate strands of the literature. In models with trend productivity growth, the labor market matters only due to wage rigidity and firms adjust labor input only along what is known as the intensive margin (hours worked). Thus, they can not account for unemployment fluctuations and other labor market outcomes. Models including labor market frictions take account of unemployment and generate output persistence. However, their quantitative properties have been shown to be counterfactual. Moreover, the dynamics in these models are driven by temporary productivity shocks, with no role for trend productivity growth. Consequently, they can not deal with issues such as how a change in trend productivity growth affects unemployment. The project aims at merging the two strands of the literature with the goal of having a unified framework for the analysis of monetary and fiscal policy that (i) better fits the stylized facts, e.g., unemployment fluctuations, and (ii) allows for the interaction of business cycle and growth effects. Alternative labor market frictions will be modelled and calibrated for the US and Germany in order to analyze optimal policy responses to temporary and permanent shocks.

• DFG Programme: Research Grants