Trend Productivity Growth and Labor Market Frictions in a New Keynesian Business Cycle Model
Final Report Abstract
Our analysis shows that both job turnover and trend productivity growth impart a substantial expansionary influence on the effect of long-run money growth on real macroeconomic activity. In their presence the optimal inflation rate is shown to be around 1.8%, which is very close to the inflation target of major world central banks. In their absence the implied optimal inflation rate is significantly lower, around 0.4%. Our analysis shows that,by increasing the effective discount rate, thereby making wages less responsive to future labor market developments,higher trend growth exacerbates the inefficiencies of the labor market and therefore calls for larger deviations from price stability so as to mitigate those inefficiencies.Our results have some bearing on how trend growth is likely to affect the likelihood of hitting the zero lower bound on nominal interest rate. Interestingly, in the presence of real shocks, we find that the optimal decline in the nominal interest rate is smaller the lower is trend growth, suggesting that the zero lower bound is hit less likely to be binding when growth slowsdown. Our analysis shows that a business cycle model with price rigidity (and thus a role for trend inflation and monetary policy),can rationalizethe productivity slowdown and the accompanying rise in unemployment across industrialized economies in the 1970s. Without price rigidity the predictions of labor search models of unemployment turn out to be counterfactual. We show that the New-Keynesian model with frictional unemployment can rationalize the trend decline in productivity growth and the average number of hours worked, as observed across industrialized countries during the postwar period. Slower productivity growth decreases hours worked by reducing the effective discount rate and in turn (i) increasing the price markup, which acts like a tax hike on labor supply, and (ii) increasing the present discounted value of lifetime revenues, which acts like a wealth effect on labor supply. The presence of frictional unemployment is crucial, since without its presence the link between growth and hours vanishes when the inflation rate is zero, because of the implied constancy of the price markup.
Publications
- (2014). Growth and Unemployment in the Presence of Trend Inflation, Working Paper 1978, Kiel Institute for the World Econom
Mewael F. Tesfaselassie
- (2015). Trend Growth, Unemployment and Optimal Monetary Policy, Working Paper 2003, Kiel Institute for the World Economy
Wolfgang Lechthaler and Mewael F. Tesfaselassie
- Trend Growth, Job Turnover and Phillips Curve Tradeoffs, Kiel Inst. For the World Economy, Server IfW-Publications, Feb 2015, PDF: 29 S.
Dennis J. Snower and Mewael F. Tesfaselassie
- (2016). The Impact of Disembodied Technological Progress on Working Hours, Kiel Working Paper 2026, Kiel Institute for the World Economy
Mewael F. Tesfaselassie
