What drives the labour wedge? A comparison between CEE countries and the Euro Area

Malgorzata Skibinska

No 9061, EcoMod2016 from EcoMod

Abstract: The standard frictionless real business cycle model assumes that the wage should be equal to the firms’ marginal product of labour and the households’ marginal rate of substitution . However, the data indicates that this relationship does not hold and that the labour wedge, defined as a gap between these two objects, is characterized by large cyclical variations. This paper aims to identify the factors which might contribute to the differences in the volatilities of the labour wedge across CEE region and the EA. We look at the labour wedge through the lens of a small open economy real business cycle model with search and matching frictions on the labour market. The constructed model is estimated with Bayesian methods separately for Poland, the Czech Republic and the Euro Area and used to decompose variance of the labour wedge and perform some counterfactual simulations. Firstly, we show that the forces driving the labour wedge volatility differ across the analysed economies. While the dynamics of the gap between MRS and MPL in Poland can be attributed mainly to labour market disturbances, the consumption preference shock is the main force behind the wedge variability in the Euro Area and the Czech Republic. The bigger role of the labour market disturbances in Poland may suggest that the labour market in this country functions less smoothly, with negative consequences for welfare. Secondly, our results indicate that the differences in volatilities of the labour wedge in the analysed economies result primarily from the distinct characteristics of stochastic disturbances. However, in Poland the labour market structure also plays some role in explaining the differences vis-à-vis the EA. More precisely, lower, as compared to the Eurozone, elasticity of the matching function with respect to unemployment and higher workers’ bargaining power raise the volatility of the labour wedge in this country. The impact of heterogeneity in these parameters between the EA and the Czech Republic is rather marginal. All in all, we find heterogeneity in the labour wedge fluctuations within the CEE region. The Czech Republic seems to resemble more the EA in terms of both wedge volatility and its driving forces. Our results suggest that the labour market frictions in Poland are relatively more severe and generate fluctuations that are more harmful for social welfare.

Keywords: Poland; Czech Republic; Euro Area; Labor market issues; Business cycles (search for similar items in EconPapers)
Date: 2016-07-04
New Economics Papers: this item is included in nep-dge, nep-eec, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Journal Article: What drives the labour wedge? A comparison between CEE countries and the Euro Area (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:ekd:009007:9061

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