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Federal Reserve Bank of Chicago
On the Short-Run Effects of Labor
Market Reforms
Marcelo Veracierto
WP 2000-29
On the Short-Run Effects of
Labor Market Reforms∗
Marcelo Veracierto
Federal Reserve Bank of Chicago
September, 2003
Abstract: This paper evaluates the effects of introducing labor market flexibility into a small open economy characterized by tenure-increasing separation
taxes. The model, which is calibrated to Argentinean observations, is subjected
to different reforms: 1) the elimination of all separation costs, 2) the introduction
of temporary contracts, and 3) the elimination of the separation costs from all
new hires while freezing them on the workers that were hired prior to the reform.
Contrary to the introduction of temporary contracts, which generate a sharp recessionary adjustment, the last type of partial reform is found to be an excellent
second best alternative to a full reform.
∗
This paper is based on joint work with Fernando Alvarez. A previous version circulated
under the tittle “What are the Short-Run Effects of Introducing Labor Market Flexibility?”.
I am indebted to Hugo Hopenhayn for very useful conversations during the early stages of
this project. I would also like to thank seminar participants at Arizona State University, the
Bank of Portugal, the Federal Reserve Bank of Chicago, the NBER Summer Institute, the SED
Meetings, and Penn State University for their comments. The views expressed here do not
necessarily reflect the position of the Federal Reserve Bank of Chicago or the Federal Reserve
System. Address: Federal Reserve Bank of Chicago, Research Department, 230 South LaSalle
Street, Chicago, IL 60604. E-mail: mveracierto@frbchi.org. Phone: (312) 322-5695.
1. Introduction
For the last few decades a large number of countries have been imposing policies that penalize employers for firing workers (examples of this type of policies are severance payments,
advance notice requirements, and procedural restrictions). In recent years, though, many of
these countries have questioned the desirability of these policies and have introduced reforms
intended to bring flexibility to their labor markets. Full reforms that get rid of all firing restrictions at once are rare. The reason is very simple: Workers that are protected under the
existing firing restrictions have a strong preference to keep them, making the adoption of full
labor market reforms a politically difficult task. As a consequence, labor market flexibility
has typically been introduced through partial reforms and, in particular, through the introduction of temporary contracts. Temporary contracts allow for a trial period during which
the employer can fire a worker at little or no cost. After the trial period is over, the worker
becomes subject to regular firing restrictions. By leaving the protection of previously hired
workers intact, this type of reform avoids the stiff opposition met by full reform. Spain,
France, and Argentina are examples of countries that have introduced temporary contracts
in recent years.
The effects of eliminating firing restrictions have been extensively analyzed in the literature (e.g. Alvarez and Veracierto [3], [4], Bentolila and Bertola [7], Hopenhayn and Rogerson
[11], Millard and Mortensen [14]). More recently, a number of papers have studied the effects
of temporary contracts as well (e.g. Aguirregabiria and Alonso-Borrego [1], Alonso-Borrego,
Fernandez-Villaverde and Galdon-Sanchez, [2], Alvarez and Veracierto [5], Blanchard and
Landier [8], Cabrales and Hopenhayn [9], Nagypal [17]). By considering a more realistic
type of labor market reform these papers have made an important contribution to the literature. However, they have focused on the long-run effects, abstracting from the short-run
consequences. Analyzing the short-run effects is important not only to obtain a more complete picture of labor market reforms, but also because they may lead to a different view
about their potential benefits. The purpose of this paper is to evaluate both the shortrun and the long-run effects of temporary contracts (as well as other partial reforms) and
compare them with the consequences of introducing full reforms. Special attention will be
given to the effects on unemployment, since this has been a major concern in countries that
implemented this type of policies.1
The model used is a small open economy version of Alvarez and Veracierto [5], which in
turn is based on the search model of McCall [16] and in the equilibrium unemployment model
of Lucas and Prescott [13]. Production in the economy is done on a large number of islands
that use labor as the only input of production in a constant returns to scale technology.
The islands are subject to idiosyncratic productivity shocks that follow a Markov process
over time. At the beginning of each period, workers are distributed in some way across
the islands. After the productivity shocks are realized, the workers must decide whether
to leave the islands where they are currently located and become non-employed, or to stay
on their islands and work. Agents that work start the following period on the same islands
where they are currently located. Non-employed agents have two alternatives: to search
for a new job or to leave the labor force. If an agent searches for a new job, he randomly
arrives at one of the islands at the beginning of the following period. If an agent leaves the
labor force he obtains leisure during the current period but continues to be non-employed
during the following period. Households are constituted by a large number of members that
perfectly share their employment risk. As a consequence, agents are allocated across islands
to maximize the expected discounted value of their earnings. Labor markets are competitive:
within each island, both firms and workers take the wage rate as given.
In this economy the government imposes separation taxes whenever an agent leaves an
island. The separation taxes are rebated as a lump-sum transfer to the households. A novel
1
In fact, temporary contracts have often been introduced with the purpose of reducing unemployment.
Argentina’s 1995 reform is a clear example.
2
feature of this paper is that the separation taxes are allowed to increase with the tenure
of a worker, unlike the previous literature which assumed a constant separation tax. The
assumption that separation taxes increase with tenure is not only a significant gain in realism
but also will play a crucial role in some of the main results of this paper.
The model is parametrized to reproduce important observations for the Argentinean
economy.2 In particular, separation taxes are chosen to reproduce the tenure-dependent
mandated severance payments that characterize that economy. In turn, the technology
and preference parameters are chosen to reproduce the interest rate, the unemployment
rate, the labor force participation and the elasticity of labor supply for Argentina. Under
such parametrization, the model is simulated to evaluate how Argentina would react under
different labor market reforms. Even though the model is calibrated to the Argentinean
economy it is much broader in scope: it will shed important insights on the qualitative
effects of different types of labor market reforms.
The main results of the paper are the following. First, the welfare gains of removing
all separation taxes in Argentina are found to be small: only 0.22% in terms of consumption. The effects on employment and output are sizable, though: in the long-run, output
increases by 3.24% while employment increases by 3.77%. Second, temporary contracts of 6
months duration, like those introduced by the 1995 Argentinean labor market reform, have
negligible effects on employment, output and welfare. Third, temporary contracts of very
long duration can lead to positive welfare gains and to the same long-run outcomes as a full
reform but involve a sharp recessionary adjustment, with employment decreasing 9.5% and
output decreasing 6.4% during the first period of the reform. Fourth, a partial labor market
reform that eliminates the separation taxes on new hires and freezes them on workers that
were hired prior to the reform, leads to the same welfare gains and long-run outcomes as
2
The fact that Argentina was a small open economy at the time of its labor market reforms makes it an
ideal case to analyze using the model in this paper.
3
a full reform without generating a sharp recession. In fact, employment and output start
increasing right after the introduction of the reform. Thus, this paper finds that this type of
partial labor market reform represents an excellent second best alternative to a full reform.
The paper is organized as follows. Section 2 describes the economy, Section 3 describes
a competitive equilibrium, Section 4 calibrates the model, Section 5 presents the results and
Section 6 concludes the paper. A detailed appendix describes the computational algorithm.
2. The environment
The economy is populated by a representative household constituted by a large number of
members with names in the unit interval. The household’s preferences are given by the
following utility function:
!#
"
Ã
∞
1−φ
X
h
−
1
t
β t ln ct + B
,
1−φ
t=0
(2.1)
where 0 < β < 1 is the discount factor, ct is consumption, ht is leisure, B > 0, and φ > 0.
Every period each household member must allocate his full time endowment to working, to
searching, or to being out-of-the-labor-force, but not to more than one activity at the same
time. The total amount of household’s leisure is then given by
ht = 1 − ut − nt ,
(2.2)
where ut is the number of household members that are searching (i.e. are unemployed) and
nt is the number of household members that are working (i.e. are employed).
The consumption good is produced by a unit measure of islands. Each island has a linear
production function given by
yt = zt gt ,
where yt is output, gt is the labor input, and zt is an idiosyncratic productivity shock to
4
the island. The idiosyncratic productivity shock zt follows a finite Markov process with
transition matrix Q, where Q(z, z 0 ) is the probability that zt+1 = z 0 conditional on zt = z.
Realizations of zt are assumed to be independent across islands. Hereafter, the invariant
distribution generated by the transition matrix Q will be denoted by η.
At the beginning of every period, there is a given distribution of agents across islands.
An island cannot employ more than the total number of agents present in the island at
the beginning of the period. If an agent stays on the island where he is currently located,
he produces the consumption good and starts the following period in the same location.
Otherwise, the agent leaves the island and becomes non-employed.
A non-employed agent has two alternatives. First, he can leave the labor force in order
to contribute to household leisure. However, the following period the agent will remain
non-employed. The second alternative is to search for a new job. If the agent chooses this
alternative, he obtains zero leisure during the current period, but is randomly assigned to
one of the islands at the beginning of the following period. An important feature of the
search technology is that agents have no control upon which island they will arrive to (in
this sense, the search is “undirected”). In particular, I will assume that the agents that
search are assigned uniformly across all the islands in the economy.
3. A competitive equilibrium
This section describes a competitive equilibrium in which the government imposes employment separation taxes.3 Alvarez and Veracierto [6] show, for a similar environment, that the
equilibrium allocation is exactly the same whether the firms pay the separation taxes or the
3
While the most common form of separation costs are mandated severance payments, the literature
has often chosen to model them as separation taxes. The reason is simple. Given that they represent
a bilateral transfer, severance payments would have no effects if perfect recontracting were allowed for.
However, different institutional restrictions are believed to preclude perfect recontracting from taking place.
Modelling the mandated severance payments as separation taxes is a simple way of introducing this type of
restrictions.
5
workers. The only difference is in terms of the equilibrium process for wages. Given this
result and since it is much easier to describe, I will consider the case where workers pay the
taxes directly.
The policy regime treats workers with different tenure levels differently.4 A worker with
tenure j must pay a tax τ (j) to the government if he decides to leave. When the agent
arrives at a new island his tenure level is reset to zero, independently of the agent’s tenure
in the previous island. The total amount of separation taxes collected by the government is
rebated as lump-sum transfers to the households. For simplicity, I will assume that there is
some tenure level J such that τ (j) = τ (J) for every j > J, i.e. the government treats all
workers with tenure larger or equal to J the same way. In what follows, tenure levels will
then be indexed between 0 and J.
Within each island there are competitive labor markets. As a consequence, the wage
rate is simply given by the labor productivity z of the island. I will also assume that
the economy is small and open, and that households can freely borrow and lend at the
international interest rate 1 + r = 1/β.5 The fact that the interest rate and the wage rate at
each type of island are independent of the aggregate state of the economy will considerably
simplify the computation of an equilibrium.
The individual state of the household is given by the assets at the beginning of the period
a and the beginning of the period distribution ψ of household members across tenure and
productivity levels. Hereafter, ψ (j, z) will denote the number of household members that
have tenure j in an island with productivity z. The aggregate state of the economy is given
by the aggregate assets A and the aggregate distribution Ψ of agents across tenure and
productivity levels.
4
The tenure j of a worker in a particular island is the number of periods that the agent has been employed
on that island since the time of his arrival.
5
The assumption that the international interest rate is equal to the inverse of the discount factor is
standard: It is made to guarantee stationarity.
6
The household problem is described by the following Bellman equation:
(
H(a, ψ, A, Ψ) =max
ln c + B
0
a ,u,g
Ã
(1 − u − n)1−φ − 1
1−φ
!
)
+ βH (a0 , ψ 0 , A0 , Ψ0 )
subject to
c + a0 ≤
J
XX
z
j=0
zg (j, z) −
J
XX
z
j=0
τ (j) max (0, ψ (j, z) − g (j, z))
(3.1)
+ (1 + r) a + T (A, Ψ)
g (j, z) ≤ ψ (j, z) , for j = 0, ..., J
J
XX
g (j, z)
n =
z
j=0
0
ψ 0 (0, z 0 ) = η (z ) u
X
g (j − 1, z) Q (z, z 0 ) , for j = 1, ..., J − 1
ψ 0 (j, z 0 ) =
(3.2)
(3.3)
(3.4)
(3.5)
z
0
0
ψ (J, z ) =
X
z
[g (J − 1, z) + g (J, z)] Q (z, z 0 )
(A0 , Ψ0 ) = L (A, Ψ) ,
(3.6)
(3.7)
where g (j, z) is the number of household members with tenure j that work on an island with
productivity z, and T are the lump sum transfers from the government. Equation (3.1) is
the budget constraint of the household, which states that consumption plus savings cannot
exceed income. Income is given by the total amount of wage earnings net of separation
taxes, the interest on previously accumulated assets and the lump sum transfers. Observe
that whenever workers of tenure j leave the islands where they are currently located, i.e.
whenever g (j, z) < ψ (j, z), the household must pay a tax τ (j) per reduction in that type
of workers. Equation (3.2) states that the number of household members that work under
some given tenure and productivity level cannot exceed the number of household members of
that type at the beginning of the period. Equation (3.3) gives the total number of household
members that work. Equation (3.4) states that the number of household members that in
7
the following period have tenure equal to zero and is on an island with productivity z 0 is
given by all household members that search during the current period and arrive at an island
with productivity z 0 . Observe that the probability of arriving at an island of productivity z 0
is given by the corresponding probability under the invariant distribution η. Thus, equation
(3.4) uses the fact that agents that search become uniformly distributed across all the islands
in the economy. Equation (3.5) states that, for j = 1, ..., J − 1, the number of household
members that will have tenure j on an island with productivity z 0 in the following period,
is given by the total number of household members that have current tenure equal to j − 1
and work on an island that will transit to productivity z 0 in the following period. Similarly,
equation (3.6) states that the number of household members that will have tenure J on
an island with productivity z 0 at the beginning of the following period is given by all the
household members that either have tenure J − 1 or tenure J during the current period and
work on an island that will transit to productivity z 0 in the following period. Equation (3.7)
is the law of motion for the aggregate state of the economy, which is needed to forecast future
lump-sum transfers.
Let s(a, ψ, A, Ψ), g(j, z; a, ψ, A, Ψ), and u(a, ψ, A, Ψ) be the optimal savings, employment,
and unemployment decision rules of the household, respectively. The equilibrium law of
motion for the aggregate state of the economy L (A, Ψ) must then satisfy that
A0 = s(A, Ψ, A, Ψ)
Ψ0 (0, z 0 ) = η (z 0 ) u(A, Ψ, A, Ψ)
X
Ψ0 (j, z 0 ) =
g (j − 1, z; A, Ψ, A, Ψ) Q (z, z 0 ) , for j = 1, ..., J − 1
z
0
0
Ψ (J, z ) =
X
z
[g (J − 1, z; A, Ψ, A, Ψ) + g (J, z; A, Ψ, A, Ψ)] Q (z, z 0 ) ,
that is, the aggregate law of motion must be generated by the optimal decisions of the
representative household. Similarly, the equilibrium lump-sum transfers T (A, Ψ) are given
8
by the separation taxes paid by the representative household:
T (A, Ψ) =
J
XX
z
j=0
τ (j) max (0, Ψ (j, z) − g (j, z; A, Ψ, A, Ψ)) .
3.1. Characterization
In what follows I provide a characterization of a competitive equilibrium. To simplify the
notation I will define the economy-wide employment and unemployment decision rules as
follows
G (j, z; A, Ψ) = g (j, z; A, Ψ, A, Ψ) , for j = 0, .., J
U (A, Ψ) = u(A, Ψ, A, Ψ).
Let v(j, z) be the value to the household of having a household member of tenure j on an
island with productivity z and let θ be the value to the household of having a non-employed
household member.6 If the household is indeed optimizing, these values must satisfy the
following functional equation:
(
)
X
v (j, z) = max z + β v (max {j + 1, J} , z 0 ) Q(z, z 0 ), θ − τ (j) , for j = 0, ..., J.
(3.8)
z0
Equation (3.8) states that a household member with tenure j on an island with productivity
z is allocated to the best of two alternatives. The first alternative is to work on the island
and earn a wage rate equal to z during the current period. The following period the agent’s
tenure on the island increases by one period (except when the tenure is already equal to J)
while the island transits to a new productivity shock according to the transition function Q.
The second alternative is to leave the island and obtain the value of non-employment θ after
6
These values are expressed in consumption units.
9
payment of the separation tax τ (j).
The equilibrium employment decisions G(j, z; A, Ψ) are straightforward. For j = 0, ..., J,
G(j, z; A, Ψ) =
Ψ (j, z) , if v(j, z) > θ − τ (j)
0, otherwise
.
(3.9)
That is, for each tenure and productivity level, everybody stay if the value of staying is
larger than the value of leaving. Otherwise, everybody leave.
Aggregate employment is then given by:
N (A, Ψ) =
J
XX
z
G(j, z; A, Ψ),
(3.10)
zG(j, z; A, Ψ).
(3.11)
j=0
and aggregate output is:
Y (A, Ψ) =
J
XX
z
j=0
The household allocates non-employed members between unemployment and out-of-thelabor-force until the household is indifferent to both alternatives. As a consequence, the
value of non-employment must be equal to the value of search:
θ=β
X
v (0, z 0 ) η (z 0 ) .
(3.12)
z0
The value of search is the present discounted value of randomly arriving at one of the islands
with a tenure level equal to zero. Substituting this expression in equation (3.8) shows that
there was no loss of generality in assuming that θ is a constant independent of the state of
the economy. The above indifference condition also requires that
θ = B (1 − U(A, Ψ) − N(A, Ψ))−φ C + βθ.
(3.13)
This equation states that the value of being non-employed must be equal to the value of
10
being out-of-the-labor-force for one period, which is given by the marginal utility of leisure
(expressed in consumption units), plus the present value of being non-employed during the
following period. Observe that, while unemployment U (A, Ψ) and aggregate employment
N (A, Ψ) depend on the aggregate state of the economy, consumption C is constant along
the equilibrium path. The reason is that the international interest rate 1 + r equals the
inverse of the discount factor β. Since both θ and C are constant, equation (3.13) states
that out-of-the-labor-force 1 − U (A, Ψ) − N (A, Ψ) is also constant along an equilibrium
path.
Finally, the equilibrium law of motion for the distribution Ψ is provided by:
Ψ0 (0, z 0 ) = η (z 0 ) U(A, Ψ)
X
Ψ0 (j, z 0 ) =
G (j − 1, z; A, Ψ) Q (z, z 0 ) , for j = 1, ..., J − 1
(3.14)
(3.15)
z
Ψ0 (J, z 0 ) =
X
z
[G (J − 1, z; A, Ψ) + G (J, z; A, Ψ)] Q (z, z 0 ) ,
(3.16)
while the equilibrium law of motion for asset holdings satisfies
A0 = Y (A, Ψ) +
1
A − C.
β
(3.17)
Observe from equations (3.9), (3.10), (3.11) and (3.13) that the employment rules G (j, A, Ψ),
aggregate employment N (A, Ψ), aggregate output Y (A, Ψ), and unemployment U (A, Ψ) actually do not depend on the assets level A, only on the distribution Ψ. Solving equation
(3.17) forward, we see that the initial amount of assets A0 is an important determinant of the
consumption level C, which affects the amount of labor force participation through equation
(3.13). Labor force participation in turn determines the evolution of the distribution Ψ in
equations (3.14), (3.15), and (3.16). Thus, while the path for assets can be obtained as a
mere residual from equation (3.17), the initial amount of assets is a key determinant of the
equilibrium variables.
11
4. Parametrization of the benchmark economy
This section describes the choice of parameter values for the benchmark economy. There are
four parameters to be determined, β, φ, B, and A, the set of values for the idiosyncratic
productivity shocks z, the transition matrix Q, and the separation taxes τ (j). Their values
are selected so that the steady state corresponding to the assets level A reproduces important
observations for the Argentinean economy.7 The model time period is chosen to be half-aquarter to allow for the possibility of short spells of unemployment and to obtain more
detailed short-run dynamics, which is the focus of this paper.
Observe that, by assumption, the discount factor β is related to the model real interest
rate according to 1 + r = β −1 . Given that Argentina is a small open economy, it seems
reasonable to select β to match the international interest rate. For this reason, a discount
factor β = 0.9951 is chosen to generate an annual interest rate of 4%, which is approximately
the interest rate for the United States.
The set of values for the idiosyncratic productivity shocks z and the transition matrix Q
are restricted to approximate the following AR(1) process:
ln zt+1 = ρ ln zt + εt+1 ,
where εt+1 ∼ N(0, σ 2 ), and 0 < ρ < 1.8 Both the persistence of the productivity shock ρ
and the variance of its innovations σ 2 are key determinants of the decisions to search. As
a consequence, they are selected to generate an unemployment rate of 15% and an average
duration of unemployment equal to 4 months. This requires that ρ = 0.95 and σ 2 = 0.0189.
An unemployment rate equal to 15% was the normal level for Argentina during the late
7
A steady state is a competitive equilibrium such that At = A and Ψt = Ψ, for t = 0, 1, ..., ∞. For the
model economy described in this paper there exists a different steady state for each possible value of the
assets level A.
8
A total of 120 values for z will be allowed in the computations.
12
nineties, while an average duration of unemployment equal to 4 months is the magnitude
reported by Galiani and Hopenhayn [10].
The weight B and the curvature φ of leisure in the utility function are important determinants of the labor force participation decisions. For this reason, a weight of leisure B = 0.629
is chosen to generate a labor force participation equal to 72%, the level for Argentina during
the late nineties. In turn, a curvature parameter φ = 0.55 is chosen to generate an elasticity of labor force participation with respect to wages equal to 0.7, which is consistent with
evidence for the Argentinean economy (MTSS [15]).
The amount of assets A in turn is selected to reproduce Argentina’s foreign net indebtedness. According to the IMF [12], the international liabilities of Argentina in 1998 amounted
to $207 billion while their international assets totalled $140 billion. Since Argentina’s GDP
was $299 billion, this suggests choosing a negative value for A so that the model debt to
annual output ratio equals 22%. A value of A = −1.92 turns out to be consistent with this
observation.
Finally, the policy regime is selected to reproduce important features of the Argentinean
system. Before the 1995 reform, which introduced temporary contracts, the Argentinean
labor market regime had been surprisingly stable. It was characterized by a lack of unemployment insurance and by severance payments that increased with the worker’s tenure. In
particular, the severance payments required by the government amounted to one month of
wages per year worked. To mimic this system, the tax schedule in the model economy is
restricted to the following form:
τ (j) = jb
τ , for j = 0, 1, ..., J.
Observe that workers with zero tenure are subject to no separation taxes and that each
period of employment increases the separation taxes by b
τ . The tax increment b
τ was selected
so that the separation taxes after one year of employment τ (8) equal one month of model
13
wages.9 This required that b
τ = 0.1468. The upper bound J on tenure levels was set at
96, leading to an upper bound for the separation taxes equal to one year of wages. Given
the relatively short average duration of employment, very few workers end up making the
maximum payment.
5. Results
This section evaluates different ways of introducing labor market flexibility to the benchmark
economy that was calibrated in the previous section. The labor market reforms analyzed are
the following: 1) elimination of all separation costs, 2) introduction of temporary contracts,
and 3) elimination of the separation costs from all new hires, while freezing them on the
workers that were hired prior to the reform.
5.1. Elimination of all separation costs
Starting from the benchmark equilibrium with separation taxes (calibrated in the previous
section), the government announces that there will be no more separation costs in the future.
The reform applies not only to the new hires, but to the workers that had been hired prior
to the reform. The separation taxes are then given by
τ (j) = 0 for j = 0, ..., J ∗ ,
and the initial distribution Ψ0 is given by
Ψ0 (j, z) = Ψ∗ (j, z), for j = 0, ..., J ∗ , and for all z,
9
Recall that one year is made of eight model periods.
14
where Ψ∗ and J ∗ are the steady state distribution and the upper bound on tenure levels
for the benchmark economy, respectively. Figure 1 shows the short-run effects of the reform
while the second column of Table 1 shows the long-run effects.10
Figure 1.A shows, for j = 0, ..., J ∗ , the productivity thresholds z̄(j) that trigger employment separation.11 Under laissez-faire, since τ (j) = 0 for every j, the productivity
thresholds are independent of j. On the contrary, in the benchmark economy the productivity thresholds decline with j because the separation taxes τ (j) are increasing in j. Observe
that switching to a laissez-faire regime decreases the productivity thresholds at low j’s and
increases them at high j’s. This is quite intuitive. In the economy with separation taxes
workers are very picky about accepting a new employment opportunity, but lower their
standards (once they are hired) as their separation taxes start to increase. The change in
productivity thresholds across regimes has important implications for the behavior of the
economy during the first period of the reform. Figure 1.B shows that the decrease in the
productivity threshold corresponding to j = 0 makes the job-acceptance rate (defined as the
fraction of the new arrivals that accept employment) increase during the first period of the
reform and stay constant thereafter.12 On the other hand, the job-separation rate (defined
as the fraction of previously employed workers who leave their islands) declines during the
first period of the reform. The reason is that the average duration of employment is quite
short: only 15 periods. Since most of the workers have relatively small j’s, the decrease in
productivity thresholds at small j’s (in Figure 1.A) becomes the dominant effect, reducing
the aggregate job-separation rate on impact. With the larger job-acceptance rate and the
10
The steady state values of all variables are normalized to 100 in the benchmark economy, except for the
unemployment rate, which is measured in its original units. The welfare measure reported in Table 1 is the
permanent proportionate increase in consumption that should be given to the representative household in
the benchmark economy, to make it indifferent with switching to the corresponding reform.
11
The productivity threshold z̄(j) is the largest z satisfying that v(j, z) = θ − τ (j).
12
The constant job acceptance rate is given by the sum of the probabilities η(z) across all z’s greater than
z̄(0).
15
lower job-separation rate, Figure 1.C shows that there is a slight increase in aggregate employment during the first period of the reform. However, labor force participation increases
quite substantially due to the permanent elimination of all separation taxes. Given that
the new entrants have to search before they become employed, the economy experiences a
big increase in unemployment during the first period of the reform. In fact the unemployment rate jumps from 15.0% to 17.1% during that initial period. The decrease in aggregate
productivity during the first period of the reform shown in Figure 1.D is a consequence of
the decrease in productivity thresholds at low j’s. Despite the lower aggregate productivity,
output increases because of the increase in employment. After the first period of the reform,
there is a substantial increase in employment, as the larger number of unemployed agents
(that came from the home sector) find jobs at the higher job-acceptance rate. Observe that
the job-separation rate starts to increase after the first period of the reform because more
islands transit to lower productivity levels that are closer to the new lower thresholds (at
low j’s) and are therefore more likely to cross them.13 This is also the reason why aggregate productivity in Figure 1.D continues to decrease after the first period of the reform.
However, output grows at a fast pace due to the strong increase in employment.
Table 1 shows that removing all firing taxes increases both the long-run job-acceptance
rate and the job-separation rate. This was anticipated because of the lower costs of reallocating workers across islands. What is interesting, though, is that the increase is much larger
for the job-acceptance rate, leading to a lower long-run unemployment rate despite its initial
increase during the first period of the reform. The particular structure of the productivity
shocks and separation taxes in the benchmark economy explains this result. Given that the
productivity shocks are very persistent, when a worker accepts employment he expects to
remain in the same island for a long time. As a consequence, he expects that the sepa13
Observe that there is mean reversion in the productivity levels and that the mean value of z is approximately equal to 1 (much lower than the productivity thresholds at low j’s).
16
ration costs will be high when he decides to leave later on. This makes the worker quite
conservative about which islands to accept employment from, leading to a relatively low jobacceptance rate in the benchmark economy. On the other hand, given that the separation
taxes increase slowly with the tenure level, the productivity thresholds decrease very slowly
after the workers are hired. As a consequence, the probability of receiving a productivity
realization below the thresholds remains high and the job-separation rate is relatively large
in the benchmark economy. This explains why the job-separation rate increases much less
than the job-acceptance rate when moving to the laissez-faire economy.
In terms of welfare levels, we see that the benefits of removing the separation taxes are
rather small: only 0.22% in terms of consumption. This contrasts with the previous literature,
which reported large welfare benefits of eliminating separation taxes (e.g. Hopenhayn and
Rogerson [11], Veracierto [18]). The main reason for the different result is the way that the
separation taxes have been introduced. While in this paper the separation taxes increase
linearly with tenure levels, the previous literature introduced separation taxes that jump to
a constant value right after the workers become hired. This leads to very different effects.
When the separation taxes jump to a (large) constant value right after hiring, the workers
that search become very reluctant to accept employment and the workers that have been
employed (even those recently hired) become very reluctant to leave their jobs. Given their
larger effects on the job acceptance and job separation rates, the constant separation taxes
become more distortionary and produce larger welfare effects than the tenure-increasing
separation taxes.14
14
To test this intuition I performed the following experiment. Starting from the benchmark equilibrium
reported in the first column of Table 1, I eliminated the tenure-increasing separation taxes and introduced
a constant separation tax equal to the average separation taxes actually paid in the benchmark economy
(which amount to two months of wages). I found that the constant separation tax reduced the job acceptance
rate by 23% and the job separation rate by 45%, relative to the benchmark economy. In turn, it decreased
welfare by 1.4%.
17
5.2. Temporary contracts of short duration
This section analyzes the effects of introducing a temporary contracts regime with the following characteristics. Whenever an agent enters an island for the first time he begins a trial
period of fixed duration T , during which he can leave the island at no cost. After the trial
period is over (i.e. T + 1 periods after the arrival to the island), the agent becomes a permanent worker and is subject to the same schedule of separation taxes as in the benchmark
economy. In particular, the separation taxes are now given by:
τ (j) = 0, for j = 0, ..., T
τ (j) = τ ∗ (j − T ), for j = T + 1, ..., T + J ∗
and the initial distribution Ψ0 is given by
Ψ0 (0, z) = Ψ∗ (0, z), for all z,
Ψ0 (j, z) = 0, for j = 1, ..., T and all z,
Ψ0 (j, z) = Ψ∗ (j − T, z), for j = T + 1, ..., T + J ∗ and all z,
where Ψ∗ , J ∗ and τ ∗ are the steady state distribution, the upper bound on tenure levels and
the separation taxes for the benchmark economy, respectively.15 Observe that the workers
that searched during the period prior to the reform are allowed to begin a new temporary
contract during the first period of the reform, while the workers that were employed prior to
the reform are treated as permanent workers subject to the same separation taxes that they
would have faced before the reform. In particular, if a worker was employed with tenure
j − 1 during the period prior to the reform, he is considered to have tenure j + T during the
first period of the reform. This way of introducing temporary contracts resembles the 1995
15
Note that the case T = 0 reduces to the benchmark economy.
18
Argentinean labor market reform. The length of the trial period T is set to 4 to match the
six months temporary contracts introduced by that reform. Figure 2 shows the short-run
effects of the reform while the third column of Table 1 shows its long-run effects.
Figure 2.A shows, for j = 0, ..., T + J ∗ , the productivity thresholds z̄(j) that trigger
employment separation. We see that the productivity threshold for the new arrivals (i.e.
for j = 0) is low, but that it increases over the trial period. This is quite intuitive: as the
worker gets closer to being subject to the separation taxes, the benefits of being employed at
a given productivity level decreases relative to the value of search. Indeed, Figure 2.A shows
that there is a sharp increase in the productivity threshold right before the worker becomes
subject to the separation taxes. After the trial period is over, the productivity threshold
decreases with the tenure level as the separation taxes increase.
To evaluate the initial effects of the reform, Figure 2.A also shows the productivity
thresholds that each initial type of worker would had if the benchmark regime were continued
for one more period. That is for j = 0, Figure 2.A shows the benchmark productivity
threshold z̄ ∗ (0), and for j > T it shows z̄ ∗ (j − T ).16 We see that the decrease in the
productivity threshold for workers with j = 0 leads to a substantial increase in the jobacceptance rate in Figure 2.B. The reason this productivity threshold decreases is very simple:
Accepting a new job becomes less costly because agents are not subject to separation taxes
during their first T periods of employment. However, the productivity thresholds of the
agents that have been employed during the period prior to the reform (i.e. agents with j > T )
increase. The reason is that they now have the possibility of leaving their positions in order
to restart a new trial period. In fact, we see in Figure 2.B that this leads to a spike in the jobseparation rate during the first period of the reform. The increase in the job-separation rate is
substantially larger than the increase in the job-acceptance rate, and aggregate employment
starts decreasing during the first period of the reform (contrary to the laissez-faire reform).
16
Observe that there are no workers with tenure j between 1 and T during the first period of the reform.
19
Labor force participation increases because the trial periods lower the separation taxes, but
since the trial period is short the increase is relatively small (compared to the laissez-faire
economy). Despite the small increase in labor force participation, unemployment increases
substantially during the first period of the reform due to the large increase in the jobseparation rate. In fact the unemployment rate increases by the same amount as it did in
the laissez-faire economy: from 15.0% to 17.1%.
Since most of the workers that are employed in the first period of the reform have been
employed in the period previous to the reform (their initial j is larger than T ) and the
productivity thresholds for this type of workers increase uniformly, we see in Figure 2.D that
aggregate productivity starts increasing on impact. However, output decreases due to the
decrease in employment.17
After the first period of the reform, the job-separation rate starts to decrease as more
workers become employed in trial periods (which have relatively low productivity thresholds), but five periods after the reform it begins to increase as workers start to leave their
employment positions before gaining permanent status. In the long-run, the increase in the
job-separation rate is larger than in the job-acceptance rate and the unemployment rate
increases from 15.0% to 15.7% (contrary to the laissez-faire economy).18 Employment is
roughly unchanged in the long-run because the larger unemployment rate is compensated
by the higher labor force participation. However, long-run output increases by 0.9% due
to the productivity gains. Observe that the there are no welfare gains of introducing an
Argentinean type of temporary contracts reform: the consumption equivalent gain is equal
to 0.01%.
17
These results suggest that the labor market reforms introduced by Argentina in 1995 probably aggravated
the severity of the recession originated by the Mexican devaluation (commonly known as the “tequila effect”).
18
Observe that the temporary contracts generate substantially more job turnover than laissez-faire.
20
5.3. Temporary contracts of long duration
The Argentinean reform was quite timid in terms of the length of the temporary contracts
that it introduced, leading to zero welfare gains. Other countries, like France and Spain, introduced temporary contracts of much longer durations. This is a considerable improvement
since the longer the temporary contracts, the closer to laissez-faire the long-run outcomes
will be. To illustrate this point this section considers temporary contracts with a very long
duration: mainly, a duration of 10 years (i.e. T = 80). The fourth column of Table 1 indeed
shows that the long-run effects of this type of temporary contracts are virtually the same as
laissez-faire. The intuition for this result is quite simple: With long temporary contracts,
it is very unlikely that a worker will finish the trial period before he leaves his job due to a
low productivity shock. As a consequence, the long-run job-acceptance and job-separation
decisions of most of the workers will be similar to those under laissez-faire. However, we will
see that the short-run dynamics are extremely different.
Figure 3.A shows that the productivity threshold for j = 0 is significantly lower than the
benchmark value z̄ ∗ (0), leading to a substantial increase in the job-acceptance rate (for the
above reasons, the new threshold z̄(0) is actually the same as under laissez-faire). However,
the productivity thresholds of workers that were employed prior to the reform (i.e. those with
j > T ) increase substantially relative to their benchmark values. The reason is that the value
of search increases quite significantly (since workers can now regain employment under a long
trial period), while staying in a pre-reform employment leads to higher separation taxes over
time. As a consequence, there is a huge spike in the job-separation rate during the first
period of the reform (see Figure 3.B), which translates into an immediate contraction of
9.5% in aggregate employment (see Figure 3.C).19 Labor force participation increases by the
same amount as under laissez-faire because workers expect that they will hardly ever finish
a trial period (thus avoiding the separation taxes). This large destruction of employment
19
Note that Figure 3 has a different scale from the rest of the figures.
21
together with the substantial increase in labor force participation lead to a large increase in
unemployment. In fact, the unemployment rate jumps from 15.0% to 25.4% during the first
period of the reform. The initial increase in productivity due to the separation of workers
from relatively bad islands is compensated by the large decrease in aggregate employment,
leading to a 6.4% decrease in output during the first period of the reform..
Thus, we see that temporary contracts of long duration are able to reproduce laissez-faire
outcomes in the long-run but require a sharp recessionary adjustment in the short-run. The
welfare gains are smaller than under a full reform (because of the recessionary adjustment)
but remain positive: 0.14% in terms of consumption. However, policy makers will typically
be concerned about the negative short-term outcomes and will be reluctant to introduce this
type of reform. To guarantee that a reform is implemented and that the welfare gains are
closer to potential, it is important to design a reform that delivers positive outcomes both
in the long-run and the short-run. The next section explores one possibility.
5.4. New flexible contracts with a freeze on previous separation taxes
This section introduces a labor market reform with the following characteristics. All the new
hires that take place after the reform become free of separation taxes. On the other hand, the
separation taxes of workers that were hired prior to the reform are frozen at their pre-reform
levels. Once these workers leave their pre-reform employments and pay their corresponding
separation taxes, they become free of any subsequent separation taxes in their new jobs.
The equations describing a competitive equilibrium for this regime are somewhat different
than before. The value of a household member with tenure j in an island with productivity
z must now satisfy the following functional equation:
(
)
X
v (j, z) = max z + β v (j, z 0 ) Q(z, z 0 ), θ − τ (j) , for j = 0, ..., J.
(5.1)
z0
This equation is similar to (3.8) except that the tenure level for tax purposes does not increase
22
over time (since the separation taxes are now frozen).
Equations (3.9), (3.10), (3.11), (3.12), (3.13) and (3.17) remain the same as before. The
only additional modification is the law of motion for the distribution Ψ which now becomes
Ψ0 (0, z 0 ) = η (z 0 ) U(A, Ψ) +
0
0
Ψ (j, z ) =
X
X
G (0, z; A, Ψ) Q (z, z 0 )
(5.2)
G (j, z; A, Ψ) Q (z, z 0 ) , for j = 1, ..., J.
(5.3)
z
z
Observe that when workers with tenure j > 0 leave their islands, they never regain a positive
tenure again: j = 0 becomes an absorbing state.
Since we are interested in introducing this type of reform to the benchmark economy, the
separation taxes are given by
τ (j) = τ ∗ (j) for j = 0, ..., J ∗ ,
and the initial distribution Ψ0 is given by
Ψ0 (j, z) = Ψ∗ (j, z), for j = 0, ..., J ∗ , and for all z,
where Ψ∗ , J ∗ and τ ∗ are the steady state distribution, the upper bound on tenure levels and
the separation taxes for the benchmark economy, respectively. Observe that τ ∗ (0) = 0, so
the new hires in the post-reform regime are permanently waived from paying any separation
taxes. Figure 4 shows the short-run effects of the reform while the last column of Table 1
shows the long-run effects.
Since the reform eventually leads to a laissez-faire equilibrium, the long-run effects of
this reform are virtually the same as moving to laissez-faire at once.20 Recall that introduc20
The reason why the long-run effects are not the exactly same in both reforms is that they lead to different
short-run dynamics and, consequently, to different long-run assets.
23
ing temporary contracts of long duration also led to laissez-faire outcomes in the long-run,
but involved a sharp labor market adjustment in the short-run. The key question will be
whether the partial reform considered in this section leads to a similar recessionary short-run
adjustment or not. Figure 4 provides the answer.
Figure 4.A depicts the productivity thresholds for the benchmark economy and for the
new regime, for j = 0, ..., J ∗ . It shows that the productivity threshold z̄(0) is much lower in
the new regime than in the benchmark economy. The reason for this is that the new hires will
never be subject to separation taxes. In fact the productivity threshold z̄(0) that corresponds
to the new regime is exactly the same as under laissez-faire, leading to the same (higher)
job-acceptance rate (see Figure 4.B). While this result is similar to that obtained under long
temporary contracts there is a very important difference: The productivity thresholds of
workers that have been employed prior to the reform ( i.e. those with j > 0) are much lower
in the new regime than in the benchmark economy (except for very high j’s). At first sight
this may seem a surprising result: The value of search increases quite substantially due to
the fact that the new hires will never be subject to separation taxes again and this should
increase the productivity thresholds. However, since the separation taxes are now frozen, the
workers have no reason to leave their jobs as quickly as they did in the benchmark economy.
This last effect happens to dominate and the productivity thresholds of workers with j > 0
decrease quite significantly.
The decrease in threshold levels for j > 0 leads to a reduction in the job-separation
rate in the first period of the reform. With the lower job-separation rate and the higher
job-acceptance rate, aggregate employment increases during that first period. The decrease
in productivity thresholds (except for very high j’s) lowers aggregate productivity. However,
output increases due to the significant increase in employment. Labor force participation
increases by the same amount as under laissez-faire because of the removal of the separation
taxes from all the new hires. This increase is so large that it compensates for the lower job
24
destruction rate, and increases unemployment. In fact, the unemployment rate jumps from
15.0% to 16.2% during the first period of the reform, a somewhat lower increase than in the
laissez-faire reform.
Thus, contrary to the temporary contracts of long duration, this partial reform generates
similar outcomes as the laissez-faire reform, both in the long-run and the short-run, and
leads to the same welfare gains. By avoiding the tough short-run adjustment required by the
long temporary contracts, this type of partial reform represents a very useful second-best
alternative.
6. Conclusions
This paper has analyzed the effects of introducing labor market flexibility into a small open
economy subject to tenure-increasing separation taxes. Different reforms were considered:
1) the elimination of all separation costs, 2) the introduction of temporary contracts, and 3)
the elimination of the separation costs from all new hires while freezing them on the workers
that were hired prior to the reform. Calibrating the model economy to Argentinean data, the
following results were obtained. First, the potential welfare gains of removing all separation
taxes in Argentina are small: only 0.22% in terms of consumption. However, the effects
on output and employment are sizable: in the long-run they increase by 3.24% and 3.77%,
respectively. Second, temporary contracts of 6 months duration, like those introduced by the
1995 Argentinean labor market reform, have negligible effects on employment, output and
welfare. Third, introducing temporary contracts of very long duration can lead to positive
welfare gains and to the same long-run outcomes as a full reform but involve a sharp shortrun recession. Fourth, a partial labor market reform that removes separation taxes on the
new hires and freezes them on workers that were hired prior to the reform leads to the
same welfare gains and long-run outcomes as a full reform without generating a recessionary
adjustment. Thus, the paper finds that this type of partial labor market reform constitutes
25
an excellent second-best alternative to a full reform.
The main reason why temporary contracts of long duration generate a sharp recession,
while the flexible new contracts (with a freeze on separation taxes) do not, is that they
affect job-separation decisions in very different ways. When long temporary contracts are
introduced, the value of search increases because the workers can start long trial periods
with zero separation taxes. Given that the temporary contracts regime continues to penalize
permanent workers for staying in their jobs (their separation taxes continue to increase with
tenure), the higher value of search leads many permanent workers to leave their pre-reform
jobs right after the reform is implemented.
The flexible new contracts with a freeze on separation taxes also increases the value of
search (this time because the new jobs will never be subject to separation taxes). This tends
to increase the job-separation rate. However, the freeze on separation taxes removes the
same-job penalty, inducing workers to stay in their jobs much longer. This effect is so large
that it dominates the higher value of search and leads to a lower job-separation rate when
the reform is implemented.
While this paper provided important insight about the short-run effects of labor market
reforms, there are two caveats to the analysis. The first one is the assumption of perfect risk
sharing between a large number of household members. While it is quite plausible that the
extended family in Argentina provides a more important safety network than in many other
countries, the full risk-sharing assumption is rather extreme. However, the introduction of
borrowing constraints should not change the results quite substantially. The reason is that
the average duration of unemployment is very low in Argentina: only 4 months, as reported
by Galiani and Hopenhayn [10]. Thus, similarly to other models calibrated to U.S. data, the
workers would end up self-insuring quite well using their own savings.
Another caveat to the analysis is the assumption that labor is the only factor of production. Veracierto [18] shows that, in a closed economy, the presence of capital can substantially
26
affect the short-run dynamics after a labor-market reform is introduced. However, it is unlikely that a similar result would be obtained for a small open economy. An important
reason why the presence of capital affects labor supply decisions in a closed economy is that
higher investment requires lower consumption. It is to mitigate the consumption adjustment
associated with the higher investment that agents decide to increase their labor supply along
the transitionary path. In a small open economy this channel is absent: Due to international
borrowing and lending, changes in the stock of capital do not require consumption adjustments. In fact, consumption always jumps to its new steady state level after a labor market
reform. Given the absence of this important channel, given that determining empirically
relevant capital adjustment costs for Argentina in the mid 90’s would be a difficult task, and
given the computational complexity that it would entail, I leave the introduction of capital
to future research.
A. Appendix
This appendix describes the computational algorithm. Substituting equation (3.12) in equations (3.8), the values v(j, z) can be obtained using standard recursive methods. The value
of non-employment θ is then obtained from (3.12). These values are sufficient to determine
the employment decision rules G(j, z; Ψ) in equation (3.9).
Now, guess a value for out-of-the-labor-force H (which is known to be constant along the
27
equilibrium path). Starting from the initial distribution Ψ0 at date 0, compute
Nt =
J
XX
z
Yt =
j=0
J
XX
z
G(j, z; Ψt )
zG(j, z; Ψt )
j=0
Ut = 1 − Nt − H
Ψt+1 (0, z 0 ) = η (z 0 ) Ut
X
Ψt+1 (j, z 0 ) =
G (j − 1, z; Ψt ) Q (z, z 0 ) , for j = 1, ..., J − 1
z
0
Ψt+1 (J, z ) =
X
z
[G (J − 1, z; Ψt ) + G (J, z; Ψt )] Q (z, z 0 ) ,
for t = 0, 1, ..., T , where T is a large number such that all variables have approximately
b that is obtained
converged. Given the initial asset level A0 , compute the consumption level C
from forward solving the household’s budget constraint:
T
X
b
C
YT
A0
=
+
.
β t Yt + β T +1
1−β
1
−
β
β
t=0
e that is obtained from equation (3.13), i.e. which
Calculate the consumption level C
satisfies
e + βθ.
θ = BH −φ C
b with C.
e If C
b 6= C,
e guess a new value for out-of-the-labor force H and start
Compare C
b
e
− C(H)
is obtained. This can be
again. Continue until a root H ∗ to the function C(H)
implemented using standard root finding methods.
28
Table 1
Steady State Effects
Benchmark Laissez- Temp. contr. Temp. contr.
New flex
economy
faire
(T = 4)
(T = 80)
contracts
Job acceptance rate
100.00
105.98
108.57
105.98
105.98
Job separation rate
100.00
101.78
114.48
102.52
101.78
Unemployment rate
15.00
14.48
15.68
14.57
14.48
Employment
100.00
103.77
100.08
103.67
103.77
Unemployment
100.00
99.65
105.52
100.28
99.65
Labor Force
100.00
103.15
100.90
103.16
103.15
Output
100.00
103.24
100.86
103.24
103.24
Consumption
100.00
103.23
100.82
103.16
103.22
Productivity
100.00
99.49
100.78
99.58
99.49
Debt
100.00
103.83
104.50
111.59
104.27
Welfare Gain
0.00
0.22
0.01
0.14
0.21
29
FIGURE 1: Laissez-faire
B. Job acceptance and job separation rate
A. Productivity thresholds
1.3
140
Job acceptance rate
130
1.2
Job separation rate
120
1.1
110
Laissez-faire
1
Benchmark
100
0.9
90
0.8
80
0
20
40
60
80
0
2
tenure j
4
6
8
10
periods since the reform
C. Employment, unemployment, and labor force participation
D. Output, productivity, and consumption
120
104
Employment
Unemployment
115
103
Participation
110
102
105
101
Output
Productivity
100
100
95
99
90
Consumption
98
0
2
4
6
periods since the reform
8
10
0
2
4
6
periods since the reform
8
10
FIGURE 2: Temporary contracts of 6 months duration (T = 4)
A. Productivity thresholds
B. Job acceptance and job separation rate
1.3
140
130
1.2
Job acceptance rate
Job separation rate
120
1.1
110
1
T=4
100
Benchmark
0.9
90
0.8
80
0
20
40
60
80
100
0
2
4
6
8
10
periods since the reform
tenure j
C. Employment, unemployment, and labor force participation
D. Output, productivity, and consumption
104
120
Employment
115
103
Unemployment
Participation
Output
Productivity
102
110
Consumption
101
105
100
100
99
95
98
0
90
0
2
4
6
periods since the reform
8
10
2
4
6
periods since the reform
8
10
FIGURE 3: Temporary contracts of 10 years duration (T = 80)
B. Job acceptance rate and job separation rate
A. Productivity thresholds
1.3
260
240
1.2
Job acceptance rate
220
Job separation rate
200
1.1
180
160
1
T = 80
140
Benchmark
120
0.9
100
80
0.8
0
20
40
60
80
100
120
140
0
160
2
4
6
8
10
periods since the reform
tenure j
C. Employment, unemployment, and labor force participation
D. Output, productivity, and consumption
104
180
102
Employment
160
Unemployment
Participation
100
140
98
Output
120
Productivity
96
100
Consumption
94
92
80
0
2
4
6
periods since the reform
8
10
0
2
4
6
periods since the reform
8
10
FIGURE 4: New flexible contracts with a freeze on separation taxes
B. Job acceptance rate and job separation rate
A. Productivity thresholds
140
1.3
130
Job acceptance rate
1.2
Job separation rate
120
1.1
110
New flexible
contracts
1
Benchmark
100
0.9
90
80
0.8
0
10
20
30
40
50
60
tenure j
70
80
0
90
2
4
6
8
10
periods since the reform
C. Employment, unemployment, and labor force participation
D. Output, productivity, and consumption
104
120
Employment
Unemployment
Participation
115
103
110
102
105
101
Output
Productivity
100
100
95
99
Consumption
98
90
0
2
4
6
periods since the reform
8
10
0
2
4
6
periods since the reform
8
10
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31
Working Paper Series
A series of research studies on regional economic issues relating to the Seventh Federal
Reserve District, and on financial and economic topics.
FDICIA After Five Years: A Review and Evaluation
George J. Benston and George G. Kaufman
WP-97-1
Money, Sticky Wages, and the Great Depression
Michael D. Bordo, Christopher J. Erceg and Charles L. Evans
WP-97-2
Price Pass-Through and Minimum Wages
Daniel Aaronson
WP-97-3
Habit Persistence and Asset Returns in an Exchange Economy
Michele Boldrin, Lawrence J. Christiano and Jonas D.M. Fisher
WP-97-4
North-South Terms of Trade: An Empirical Investigation
Michael A. Kouparitsas
WP-97-5
Interactions Between the Seasonal and Business Cycles
in Production and Inventories
Steven G. Cecchetti, Anil K. Kashyap and David W. Wilcox
WP-97-6
ΑPeso Problem≅ Explanations for Term Structure Anomalies
Geert Bekaert, Robert J. Hodrick, and David A. Marshall
WP-97-7
The Big Problem of Small Change
Thomas J. Sargent, François R. Velde
WP-97-8
Bank Capital Standards for Market Risk: A Welfare Analysis
David Marshall and Subu Venkataraman
WP-97-9
Monetary Policy and the Term Structure of Nominal Interest Rates:
Evidence and Theory
Charles L. Evans and David A. Marshall
WP-97-10
Employer Learning and Statistical Discrimination
Joseph G. Altonji and Charles R. Pierret
WP-97-11
A Model of Commodity Money, With Applications to Gresham=s Law
and the Debasement Puzzle
François R. Velde, Warren E. Weber and Randall Wright
WP-97-12
The Evolution of Small Change
Thomas J. Sargent and François R. Velde
WP-97-13
The Role of Credit Market Competition on Lending Strategies
and on Capital Accumulation
Nicola Cetorelli
WP-97-14
Algorithms for Solving Dynamic Models with Occasionally Binding Constraints
Lawrence J. Christiano and Jonas Fisher
WP-97-15
Working Paper Series (continued)
The Return from Community College Schooling for Displaced Workers
Louis S. Jacobson, Robert J. LaLonde and Daniel G. Sullivan
WP-97-16
Modeling Money
Lawrence J. Christiano, Martin Eichenbaum and Charles L. Evans
WP-97-17
Monetary Policy Shocks: What Have We Learned and to What End?
Lawrence J. Christiano, Martin Eichenbaum and Charles L. Evans
WP-97-18
Volunteer Labor Sorting Across Industries
Lewis M. Segal, Elizabeth Mauser and Burton A. Weisbrod
WP-97-19
Would Freetrade Have Emerged in North America without NAFTA?
Michael A. Kouparitsas
WP-97-20
The Role of the Financial Services Industry in the Local Economy
Douglas D. Evanoff, Philip R. Israilevich and Graham R. Schindler
WP-97-21
The Trojan Horse or the Golden Fleece? Small Business Investment
Companies and Government Guarantees
Elijah Brewer III, Hesna Genay, William E. Jackson III and Paula R. Worthington
WP-97-22
Temporary Services Employment Durations: Evidence from State UI Data
Lewis M. Segal and Daniel G. Sullivan
WP-97-23
The Determinants of State Food Manufacturing Growth: 1982-92
Mike Singer
WP-97-24
Requiem for a Market Maker: The Case of Drexel Burnham Lambert
and Below-Investment-Grade Bonds
Elijah Brewer III and William E. Jackson III
WP-97-25
Plant Level Irreversible Investment and Equilibrium Business Cycles
Marcelo Veracierto
WP-98-1
Search, Self-Insurance and Job-Security Provisions
Fernando Alvarez and Marcelo Veracierto
WP-98-2
Could Prometheus Be Bound Again? A Contribution to the Convergence Controversy
Nicola Cetorelli
WP-98-3
The Informational Advantage of Specialized Monitors:
The Case of Bank Examiners
Robert DeYoung, Mark J. Flannery, William W. Lang and Sorin M. Sorescu
WP-98-4
Prospective Deficits and the Asian Currency Crisis
Craig Burnside, Martin Eichenbaum and Sergio Rebelo
WP-98-5
Stock Market and Investment Good Prices: Implications of Microeconomics
Lawrence J. Christiano and Jonas D. M. Fisher
WP-98-6
2
Working Paper Series (continued)
Understanding the Effects of a Shock to Government Purchases
Wendy Edelberg, Martin Eichenbaum and Jonas D. M. Fisher
WP-98-7
A Model of Bimetallism
Francois R. Velde, and Warren E. Weber
WP-98-8
An Analysis of Women=s Return-to-Work Decisions Following First Birth
Lisa Barrow
WP-98-9
The Quest for the Natural Rate: Evidence from a Measure of Labor Market Turbulence
Ellen R. Rissman
WP-98-10
School Finance Reform and School District Income Sorting
Daniel Aaronson
WP-98-11
Central Banks, Asset Bubbles, and Financial Stability
George G. Kaufman
WP-98-12
Bank Time Deposit Rates and Market Discipline in Poland:
The Impact of State Ownership and Deposit Insurance Reform
Thomas S. Mondschean and Timothy P. Opiela
WP-98-13
Projected U.S. Demographics and Social Security
Mariacristina De Nardi, Selahattin ⁄mrohoro lu and Thomas J. Sargent
WP-98-14
Dynamic Trade Liberalization Analysis: Steady State, Transitional and
Inter-industry Effects
Michael Kouparitsas
WP-98-15
Can the Benefits Principle Be Applied to State-local Taxation of Business?
William H. Oakland and William A. Testa
WP-98-16
Geographic Concentration in U.S. Manufacturing: Evidence from the U.S.
Auto Supplier Industry
Thomas H. Klier
WP-98-17
Consumption-Based Modeling of Long-Horizon Returns
Kent D. Daniel and David A. Marshall
WP-98-18
Can VARs Describe Monetary Policy?
Charles L. Evans and Kenneth N. Kuttner
WP-98-19
Neighborhood Dynamics
Daniel Aaronson
WP-98-20
Inventories and output volatility
Paula R. Worthington
WP-98-21
Lending to troubled thrifts: the case of FHLBanks
Lisa K. Ashley and Elijah Brewer III
WP-98-22
3
Working Paper Series (continued)
Wage Differentials for Temporary Services Work:
Evidence from Administrative Data
Lewis M. Segal and Daniel G. Sullivan
WP-98-23
Organizational Flexibility and Employment Dynamics at Young and Old Plants
Jeffrey R. Campbell and Jonas D. M. Fisher
WP-98-24
Extracting Market Expectations from Option Prices:
Case Studies in Japanese Option Markets
Hisashi Nakamura and Shigenori Shiratsuka
WP-99-1
Measurement Errors in Japanese Consumer Price Index
Shigenori Shiratsuka
WP-99-2
Taylor Rules in a Limited Participation Model
Lawrence J. Christiano and Christopher J. Gust
WP-99-3
Maximum Likelihood in the Frequency Domain: A Time to Build Example
Lawrence J.Christiano and Robert J. Vigfusson
WP-99-4
Unskilled Workers in an Economy with Skill-Biased Technology
Shouyong Shi
WP-99-5
Product Mix and Earnings Volatility at Commercial Banks:
Evidence from a Degree of Leverage Model
Robert DeYoung and Karin P. Roland
WP-99-6
School Choice Through Relocation: Evidence from the Washington D.C. Area
Lisa Barrow
WP-99-7
Banking Market Structure, Financial Dependence and Growth:
International Evidence from Industry Data
Nicola Cetorelli and Michele Gambera
WP-99-8
Asset Price Fluctuation and Price Indices
Shigenori Shiratsuka
WP-99-9
Labor Market Policies in an Equilibrium Search Model
Fernando Alvarez and Marcelo Veracierto
WP-99-10
Hedging and Financial Fragility in Fixed Exchange Rate Regimes
Craig Burnside, Martin Eichenbaum and Sergio Rebelo
WP-99-11
Banking and Currency Crises and Systemic Risk: A Taxonomy and Review
George G. Kaufman
WP-99-12
Wealth Inequality, Intergenerational Links and Estate Taxation
Mariacristina De Nardi
WP-99-13
Habit Persistence, Asset Returns and the Business Cycle
Michele Boldrin, Lawrence J. Christiano, and Jonas D.M Fisher
WP-99-14
Does Commodity Money Eliminate the Indeterminacy of Equilibria?
WP-99-15
4
Working Paper Series (continued)
Ruilin Zhou
A Theory of Merchant Credit Card Acceptance
Sujit Chakravorti and Ted To
WP-99-16
Who’s Minding the Store? Motivating and Monitoring Hired Managers at
Small, Closely Held Firms: The Case of Commercial Banks
Robert DeYoung, Kenneth Spong and Richard J. Sullivan
WP-99-17
Assessing the Effects of Fiscal Shocks
Craig Burnside, Martin Eichenbaum and Jonas D.M. Fisher
WP-99-18
Fiscal Shocks in an Efficiency Wage Model
Craig Burnside, Martin Eichenbaum and Jonas D.M. Fisher
WP-99-19
Thoughts on Financial Derivatives, Systematic Risk, and Central
Banking: A Review of Some Recent Developments
William C. Hunter and David Marshall
WP-99-20
Testing the Stability of Implied Probability Density Functions
Robert R. Bliss and Nikolaos Panigirtzoglou
WP-99-21
Is There Evidence of the New Economy in the Data?
Michael A. Kouparitsas
WP-99-22
A Note on the Benefits of Homeownership
Daniel Aaronson
WP-99-23
The Earned Income Credit and Durable Goods Purchases
Lisa Barrow and Leslie McGranahan
WP-99-24
Globalization of Financial Institutions: Evidence from Cross-Border
Banking Performance
Allen N. Berger, Robert DeYoung, Hesna Genay and Gregory F. Udell
WP-99-25
Intrinsic Bubbles: The Case of Stock Prices A Comment
Lucy F. Ackert and William C. Hunter
WP-99-26
Deregulation and Efficiency: The Case of Private Korean Banks
Jonathan Hao, William C. Hunter and Won Keun Yang
WP-99-27
Measures of Program Performance and the Training Choices of Displaced Workers
Louis Jacobson, Robert LaLonde and Daniel Sullivan
WP-99-28
The Value of Relationships Between Small Firms and Their Lenders
Paula R. Worthington
WP-99-29
Worker Insecurity and Aggregate Wage Growth
Daniel Aaronson and Daniel G. Sullivan
WP-99-30
Does The Japanese Stock Market Price Bank Risk? Evidence from Financial
WP-99-31
5
Working Paper Series (continued)
Firm Failures
Elijah Brewer III, Hesna Genay, William Curt Hunter and George G. Kaufman
Bank Competition and Regulatory Reform: The Case of the Italian Banking Industry
Paolo Angelini and Nicola Cetorelli
WP-99-32
Dynamic Monetary Equilibrium in a Random-Matching Economy
Edward J. Green and Ruilin Zhou
WP-00-1
The Effects of Health, Wealth, and Wages on Labor Supply and Retirement Behavior
Eric French
WP-00-2
Market Discipline in the Governance of U.S. Bank Holding Companies:
Monitoring vs. Influencing
Robert R. Bliss and Mark J. Flannery
WP-00-3
Using Market Valuation to Assess the Importance and Efficiency
of Public School Spending
Lisa Barrow and Cecilia Elena Rouse
Employment Flows, Capital Mobility, and Policy Analysis
Marcelo Veracierto
Does the Community Reinvestment Act Influence Lending? An Analysis
of Changes in Bank Low-Income Mortgage Activity
Drew Dahl, Douglas D. Evanoff and Michael F. Spivey
WP-00-4
WP-00-5
WP-00-6
Subordinated Debt and Bank Capital Reform
Douglas D. Evanoff and Larry D. Wall
WP-00-7
The Labor Supply Response To (Mismeasured But) Predictable Wage Changes
Eric French
WP-00-8
For How Long Are Newly Chartered Banks Financially Fragile?
Robert DeYoung
WP-00-9
Bank Capital Regulation With and Without State-Contingent Penalties
David A. Marshall and Edward S. Prescott
WP-00-10
Why Is Productivity Procyclical? Why Do We Care?
Susanto Basu and John Fernald
WP-00-11
Oligopoly Banking and Capital Accumulation
Nicola Cetorelli and Pietro F. Peretto
WP-00-12
Puzzles in the Chinese Stock Market
John Fernald and John H. Rogers
WP-00-13
The Effects of Geographic Expansion on Bank Efficiency
Allen N. Berger and Robert DeYoung
WP-00-14
6
Working Paper Series (continued)
Idiosyncratic Risk and Aggregate Employment Dynamics
Jeffrey R. Campbell and Jonas D.M. Fisher
Post-Resolution Treatment of Depositors at Failed Banks: Implications for the Severity
of Banking Crises, Systemic Risk, and Too-Big-To-Fail
George G. Kaufman and Steven A. Seelig
WP-00-15
WP-00-16
The Double Play: Simultaneous Speculative Attacks on Currency and Equity Markets
Sujit Chakravorti and Subir Lall
WP-00-17
Capital Requirements and Competition in the Banking Industry
Peter J.G. Vlaar
WP-00-18
Financial-Intermediation Regime and Efficiency in a Boyd-Prescott Economy
Yeong-Yuh Chiang and Edward J. Green
WP-00-19
How Do Retail Prices React to Minimum Wage Increases?
James M. MacDonald and Daniel Aaronson
WP-00-20
Financial Signal Processing: A Self Calibrating Model
Robert J. Elliott, William C. Hunter and Barbara M. Jamieson
WP-00-21
An Empirical Examination of the Price-Dividend Relation with Dividend Management
Lucy F. Ackert and William C. Hunter
WP-00-22
Savings of Young Parents
Annamaria Lusardi, Ricardo Cossa, and Erin L. Krupka
WP-00-23
The Pitfalls in Inferring Risk from Financial Market Data
Robert R. Bliss
WP-00-24
What Can Account for Fluctuations in the Terms of Trade?
Marianne Baxter and Michael A. Kouparitsas
WP-00-25
Data Revisions and the Identification of Monetary Policy Shocks
Dean Croushore and Charles L. Evans
WP-00-26
Recent Evidence on the Relationship Between Unemployment and Wage Growth
Daniel Aaronson and Daniel Sullivan
WP-00-27
Supplier Relationships and Small Business Use of Trade Credit
Daniel Aaronson, Raphael Bostic, Paul Huck and Robert Townsend
WP-00-28
On the Short-Run Effects of Labor Market Reforms
Marcelo Veracierto
WP-00-29
Equilibrium Lending Mechanism and Aggregate Activity
Cheng Wang and Ruilin Zhou
WP-00-30
Impact of Independent Directors and the Regulatory Environment on Bank Merger Prices:
Evidence from Takeover Activity in the 1990s
Elijah Brewer III, William E. Jackson III, and Julapa A. Jagtiani
WP-00-31
7
@FedFRASER