Modelling labour market at the MNB Zoltán M. Jakab

Szirák2006. Nov. 4

• 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

Outline

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?

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

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..)

Price and wage persistence for Hungary:

f’cast errors of MNB• Forecast errors: if fcast is efficient explanatory variables should not

influence fcast errorsE(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)

1 4 8 1 4 8

Fogyasztói árindex (éves átlag) 0,0 -0,2 0,6 0,1 0,4 1,4Fogyasztói árindex áfával korrigálva (éves átlag) 0,0 -0,2 0,2 0,1 0,4 0,9Fogyasztói árindex (év/év) 0,0 -0,3 0,8 0,2 0,9 1,4Fogyasztói árindex áfával korrigálva (év/év) 0,0 -0,5 0,8 0,4 0,8 0,9Maginfláció (éves átlag) 0,0 0,0 0,4 0,1 1,3 1,9GDP 0,0 -0,1 -0,1 0,0 0,4 0,9Lakossági fogyasztás 0,3 1,6 1,0 0,8 1,4 2,3Állóeszköz felhalmozás -0,4 0,8 2,1 1,5 1,9 3,8Export -0,7 1,4 3,0 1,4 3,0 4,4Import -1,7 0,9 2,5 0,7 3,6 3,2Privát nominálbérek 0,1 0,6 1,9 0,2 1,1 2,1

Átlagos hiba Átlagos négyzetes hiba (RMSE)

negyedévre előre

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 )

CPI Private wages HUF/ EUR Oil prices

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2 - -- 0 0

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5 0 ++ + 0

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• 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

General modelling strategy at the MNB

• 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 market in the NEM

model

Labour

• 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?

Labour market in the NEM model:

Some issues..

EPRES

• 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?

Partial labour market equations (expert info)

• 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

The way ahead: new estimated DSGE model

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

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Capital subtituded by Labour

Labour subtituded by Capital

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

700

750

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850

900

950

1000

1050

1100

1150

1200

6 6.1 6.2 6.3 6.4 6.5 6.6 6.7

K/(effective L)

W/P

/(p

ric

e o

f in

ve

stm

en

t) 1q95

2q06

Capital subtituded by Labour

Labour subtituded by Capital

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

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?

Thank you

Labour Market Phillips Curve and main mechanisms

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GDP on employment Wage cost on employment

Productivity and prices on Wages Unemployment on Wages

Tightness

Employment

Wage bargain

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Labour demand Labour demand

Need for add-factoring employmentUnless: high employment growth

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