Essays on labour market frictions and fiscal policy

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School of Business | Doctoral thesis (article-based) | Defence date: 2012-09-07
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215 s
Aalto University publication series. DOCTORAL DISSERTATIONS, 105/2012
This thesis analyzes labour market fluctuations and fiscal policy from the perspective of a small monetary union member state, namely Finland. The first essay identifies how frictions in the labour market shape the responses of the economy to government spending shocks. The nature of offsetting fiscal measures is found to be critical for the effects of fiscal stimulus, due to the different effects of different tax instruments on the labour market. Shifting the debt-stabilizing burden towards distortionary labour taxes has detrimental effects on the labour market outcome and on general economic performance in a flexible wage regime. The results indicate that wage rigidity increases the effectiveness of fiscal policy in the short term but leads to a worse longer term development including unemployment above steady state levels. The analysis suggests that a closer look at the functioning of labour markets may help to identify fiscal policy transmission channels not captured by the standard New Keynesian model. The second essay investigates the unemployment volatility puzzle in Finland. The ability of the New Keynesian DSGE model with labour market frictions to reproduce key volatilities found in Finnish business cycle data is explored. We offer some plausible explanations of the "Shimer puzzle" for the Finnish case. Specific emphasis is put on modelling the wage bargaining framework as well as the cyclical behaviour of distortionary labour taxes. Wage rigidity is found to be a promising candidate for explaining Finnish labour market volatilities in the period 1994-2010. The much higher volatilities of the period 1981-1993 are also discussed. We find that most of the specific features that characterised the Finnish economy in that period, including during the exceptionally deep recession of the early 1990's, are such that they increase the magnitude of labour market fluctuations in the model economy. The third essay is a first attempt to estimate a DSGE model with labour market frictions and wage rigidity for the Finnish economy. The contribution is twofold. First, estimates of nominal rigidities and wage indexation that are well in line with the existing literature are obtained, and they give an economically plausible picture of the Finnish economy. Wage rigidity is found to be empirically relevant for the business cycle. A detailed assessment of the degree of wage rigidity and indexation in different model specifications is provided. Second, the estimation approach sheds more light on the magnitude and effects of labour market shocks. Labour market shocks are found to importantly drive fluctuations of labour market variables but they also account for a non-trivial share of output fluctuations.
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Haaparanta, Pertti, professor
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