Modelling labour market at the MNB Zoltán M. Jakab Szirák 2006. Nov. 4

1. Modelling labour market at the MNB Zoltán M. JakabSzirák2006. Nov. 4

2. Outline • Macro modelling and labour markets, is it useful? • Interest again focused on it among modellers • Price and wage persistence: • Inflation fcast error analysis at the MNB, what are the main findings for the labour market • Description of labour market models at the MNB • NEM model • Expert system in a nutshell • new DSGE model • Challanges to our models • Capital/labour substituion • Effective labour supply • Substitution between public and private labour

3. Macro modelling and labour markets: large focus again • Take a simple (hybrid) New-Keynesian Phillips curve common in the literature • s denotes sectors,  and  are Calvo-probability and share of indexation, respectively • Emprical fact: slow response of price inflation to real economy shocks • in Hungary also • Original assumptions:  and  produces low slope for marginal costs? • Markup shocks ()? But, usually it’s assumed to be less persistent • Fitting macro data: requires low frequency of price (wage) adjustments • : share of rule-of-thumb optimizers: empirical results are quite robust (less than 50%) • Micro evidence for prices: More frequent price adjustment than required for macro • What to do then? • understand evolution of marginal costs (mc): most notably wages • Alternative solution: variable capacity utilization (flexible inputs) at firms • Can wage(inflation) persistence account for slow response of inflation?

4. Macro modelling and labour markets: large focus again • Recent DSGE models cannot account for unemployment • Can account for wage persistence (at least can handle) • Other wawe of literature: searching and matching models • Blanchard-Gali (2006): „mixing” the two approaches • Real labour market rigidities matter for monetary policy • But Christoffel et al (2006): different wage bargaining matters for understanding business cycle facts (Nash bargain, searching) but less conclusive for monetary policy • It is still a less researched area • MNB also plans to invest in this field

5. What do we „know” about price and wage persistence for Hungary • Prices are less persistent to a monetary shock than wages, robust statement accross different models estimated for Hungary Source: Jakab-Várpalotai-Vonnák (2006) • Considerable nominal wage response to a monetary shock after the second-third years: HIGH WAGE PERSISTENCE IN OUR MODELS • Price response: much quicker (due to opennes, stronger pass-through etc..)

6. Price and wage persistence for Hungary: f’cast errors of MNB • Forecast errors: if fcast is efficient explanatory variables should not influence fcast errors E(X)=0 • What about MNB’s forecast errrors • Jakab-Kiss-Kovács (2006) analysis: • fcast errors for CPI are unbiased • fcast errors for wages are more likely to be biased and underpredicted • THIS MIGHT SHOW AN EVEN HIGHER WAGE PERSISTENCE (which is still quite high) • MNB forecasts gave right policy signals (turning points more or less matched)

7. Price and wage persistence for Hungary: f’cast errors of MNB • Formal test for efficacy: E(X)=0 • In the longer run (4-6 quarters) Nominal wages lead to Positive error (higher fact than fcast) • We still miss something! Is there even more persistence of prices than we estimated? • Or wage-price connection (marginal costs’ adjustment) is not well understood • Or Inflationary expectations are not that stable? • Need to model labour markets in a more detailed way in order to arrive at better MACRO policies, fcasts etc… • OR: is it still too early to say anything (Jakab-Kovács (2003) found that after an exchange rate shock labour market (nominal wage adjustment) works in the 3-5 years )

8. General modelling strategy at the MNB • Pluralistic approach: no model fits all • Forecasting performance crucial • Iterative method of forecasting • model based information • expert level information (disaggregated analyis also) • Consensus view in each forecast round (quarterly) • Focus on inflation means Labour market is key • Lots of issues remained unresolved • Larger human resources devoted to labour markets than previously • New projects started/will start: • Job flows • Understanding inactivity • Modelling labour market in DSGE models

9. Labour market in the NEM model • General features: • Nominal wage rigidities: • institutional determinants • wage bargain (not necessarily central) • Right-to-manage • labour demand: employers • Employment equation from profitmax • exogenous labour supply • productivity and prices (LR elast=1) • Prices: GDP-deflator • Bargaining: • Nominal wage equation: • LR unemployment effect • (elast=0.14) • level-effect on nominal wages • LR prices and productivities (employers) • Both equations are very „slow” Labour

10. Labour market in the NEM model: Some issues.. • Is unemployment measuring tightness: • Not perfectly: inactivity is also cyclical and enter-probabilities for certain inactivity groups as much as for unemployed • Problem with TREND unemployment • employment depends on output (productivity) • output depends on potential • Result: employment equation always predicts higher than actual employment growth • capital/labour substitution is a solution • Price variable: currently GDP-deflator in NEM • According to our recent view real unit labour cost deflated by CORE better in fcast • Social security contrib. bargaining • different than other bargaining? • does it effect pricing? • does it effect NAIRU? EPRES

11. Partial labour market equations (expert info) • VECM for employment and nominal wages in the private sector • LR elasticities for wage costs: price 1, productivity: 0.6-0.7 • different models for ILO and institutional employment • LR elasticities for employment: value added 1, real wage cost -0.4 • Sectoral equations (manufacturing, services) • Endogeneity with prices: not fully solved yet (NEM helps) • Issues: How to treat minimum wage effects? • How to treat bonuses, and how to disentangle bonus shocks from minimum wage shocks? • Do bonuses translate into income and consumption?

12. The way ahead: new estimated DSGE model • MNB is now building a new DSGE model • Key features: • Two sectors: traded and nontradeds • Price and wage stickiness á’lá Calvo • + indexation á’lá Smets-Wouters • habit in consumption • export market share „rigidities” • costly capital, labour and imported intermediate adjustment • General monetary policy rule incorporating both the crawling peg and inflation targeting • Modified UIP á’lá Schmitt-Grohe and Uribe • Currently calibrated version, estimation underway • Estimation method: bayesian estimation with structural break • Labour market: quite standard yet • In the future: different labour market setup (matching and/or effective wages) • Christoffel et al (2006): for Germany, different labour market setups help in better understanding business cycle features of these models, but for monetary policy design it’s not that important • Other view: Smets-Wouters (2006): less sceptical

13. Challenges to our models: K/L substitution • As mentioned before: wages might be even more persistent, what are the reasons? • Other question: Capital/Labour substitution might seem to be underway • Problem: no simple production fn can capture it • A good measure K/(L*A) against relative prices (Comp/P/Price of capital) • price of capital proxied by price of investment • Is this due to economic policy (e.g. increased public wages, minimum wages etc.) • Or is it a natural story • 95-97: FDI flows due to cheap labour and lower social securities • 2000 – sectoral story: mosty textiles

14. Challenges to our models: K/L substitution • As mentioned before: wages might be even more persistent, what are the reasons? • Other question: Capital/Labour substitution might seem to be underway • Problem: no simple production fn can capture it • A good measure K/(L*A) against relative prices (Comp/P/Price of capital) • price of capital proxied by price of investment • Is this due to economic policy (e.g. increased public wages, minimum wages etc.) • Or is it a natural story • 95-97: FDI flows due to cheap labour and lower social securities • 2000 – sectoral story: mosty textiles

15. Challenges to our models: Effective labour • In our models ILO unemployment measures labour market „tightness” • Is it a good measure? • Cseres-Gergely and Chassambouli (2006) found large flows between inactives and employed • Demographic factors: low activity rate might be due to demography and initial conditions (transition) and early retirement policies • Lamo (2006) modelled „new” and „old” industries for Poland and Estonia • Transition is low: first high U, then sharp decline • This might also happened in Hungary during 90s • Are we now in „normal times” when U is a measure for matching probabilities? • Maybe not: Sectoral reallocation of labour is still an issue

16. Challenges to our models: Substitution between public and private labour • In our models we treat them as perfect substitutes in „labour market tightness” • (U in the private wage equation) • public wages are exogenous • Public wage hike has only second round effects to private wages (though U, demand etc..) • Is it a good description?

17. Thank you

18. Employment Labour demand Wage bargain Labour demand Tightness Labour Market Phillips Curve and main mechanisms GDP on employment Wage cost on employment Productivity and prices on Wages Unemployment on Wages

19. Need for add-factoring employmentUnless: high employment growth