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Assessing the Empirical Relevance of Labour Frictions to Business Cycle Fluctuations

Joao Madeira

Oxford Bulletin of Economics and Statistics, 2018, vol. 80, issue 3, 554-574

Abstract: This paper describes a dynamic stochastic general equilibrium model augmented with labour frictions, namely: indivisible labour, predetermined employment and adjustment costs. This improves the fit to the data as shown by a higher log marginal likelihood and closer match to key business cycle statistics. The labour frictions introduced are relevant for model dynamics and economic policy: the effect of total factor productivity shocks on most macroeconomic variables is substantially mitigated; fiscal policy leads to a greater crowding out of private sector activity and monetary policy has a lower impact on output. Labour frictions also provide a better match to impulse response functions from vector autoregressive models.

Date: 2018
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