introducing unemployment and non- wasteful government ... · introducing unemployment and...

Introducing Unemployment and Non-wasteful Government Spending into

a Medium-scale DSGE model(joint work with Ryo Hasumi, JCER)

7th ESRI-CEPREMAP joint workshopNovember 13

Tatsuyoshi MatsumaeESRI, Cabinet Office

Outline

1. Introduction2. Model3. Estimation method4. Estimation Results5. Conclusion

2

1. IntroductionUnemployment rate in Japan

3

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%1980

Q2

1981

Q2

1982

Q2

1983

Q2

1984

Q2

1985

Q2

1986

Q2

1987

Q2

1988

Q2

1989

Q2

1990

Q2

1991

Q2

1992

Q2

1993

Q2

1994

Q2

1995

Q2

1996

Q2

1997

Q2

1998

Q2

1999

Q2

2000

Q2

2001

Q2

2002

Q2

2003

Q2

2004

Q2

2005

Q2

2006

Q2

2007

Q2

2008

Q2

2009

Q2

2010

Q2

2011

Q2

2012

Q2

lost decade

globalfinancialcrisis

bubbleeconomy

collapse ofthe bubble economy

1. Introduction

• Can fiscal stimuli reduce unemployment?– Conflicting empirical evidence is shown by Monacelli et al. (2010) who reply “Yes”, and Bruckner and Pappa (2012) who reply “No”.

• If fiscal stimuli reduce unemployment, then, how much do fiscal stimuli affect unemployment?

4

1. Introduction

• Our objective: – Investigate qualitative and quantitative effects of government spending for unemployment in Japan.

• This paper’s strategy: – Introducing unemployment in the fashion of Gali et al. (2012, hereafter, GSW) into a medium‐scale DSGE model as simply as possible under non‐wasteful government spending.

5

2. Model: Key features• Extending a Standard DSGE model (Smets and Wouters, 2007)

– Non‐wasteful government spending• Productive public capital• Edgeworth complementarities between government consumption and private consumption

– Unemployment• Caused by some market power of workers (proposed by Gali 2011, and GSW).

– The rest is substantially the same as Smets and Woutersmodel: habit formation on consumption, adjustment cost of investment and capital utilization rate, Calvo type nominal rigidities on price and wage, etc.

• An Estimated Medium‐scale DSGE model– 49 structural equations– 15 structural shocks

6

2. Model: Flow chart

7

Households

7

Final goods firms

Labor

Government

Monopolistic Competition

Intermediate goods firms

Capital producing firms

Private capital

Monopolistic Competition

Public capital

Capital

Intermediate goodsFinal

goodsFinal goods

2. Model: Households• Households’ behavior

– maximize the discounted present values of utilities

– Government consumption affects the inter‐temporal consumption smoothing condition of households

8

Consumption including government consumption

2. Model: Households• Wage settings of households

– Each household has a differentiated skill and has some market power.

– Under the nominal rigidity (wage revision probability 1 ‐ ξw），households decide their current wages so as to maximize the present discount value of their utilities.

– Households who cannot revise their wage optimally are assumed to index their wage with the previous inflation rate (wage persistency).

9

2. Model: Households• New Keynesian Phillips Curve (wage)

Taking into account “future” marginal cost (from disutility of working) and “future” marginal benefit (future utilities from consumption by working) since there is a possibility that they cannot revise their wage, households decide their current wages. As a result, NKPC which describes wage inflation dynamics includes forward looking terms.

10

2. Model: Unemployment– Each differentiated skilled household determines their wage to take into account their market power and nominal wage rigidity. As a result, wage and employment are determined from NKPC.

– Each household has members with heterogeneous labor disutility.

11

0= low reservation wage

1 = high reservation wage

0 1

Differentiated skills(household)

Labor disutility(household’s members)

ji k

a b c

2. Model: Unemployment– Each member is willing to supply their labor up to the marginal labor disutility with their wage: Given the real wage, desirable labor supply aggregated across members is derived as:

Real wage = MRS between labor supply and consumptionIf the real wage is temporarily constant due to nominal rigidities, then a decrease in consumption leads to an increase in labor supply.

– Employment H is determined from NKPC, ”involuntary” unemployment U is defined as the following equation:

12

• Standard story goes as follows:– Fiscal expansions create aggregate demand.– But forward‐looking households will decrease consumption because of anticipation of future tax increases (negative wealth effect).

– The decrease of consumption lowers the labor demand and also brings an incentive to work more (an increase in labor supply).

– Wage adjustment is sluggish from nominal rigidities.– If the increase in labor demand dominates the increase in labor supply, then fiscal stimuli decrease unemployment. Otherwise, fiscal stimuli increase unemployment.

13

2. Model: Unemployment


14

LD

LS = MRS (L, C)wage

labor

U

H L

Increase in aggregate demand

Negative wealth effect

Increasein labor supply

U

a

b

c

2. Model: Effects of government spending I

Productive Public Capital (PPC): – Public capital accumulation by government investment contributes to an increase in private firms’ productivity (positive externalities):

• α×αg＞0：Productivity of public capital– As a result, an accumulation of the public capital kgdecreases private firms’ marginal costs.

15

Public capital

Edgeworth Complementarities (EC): – Government consumption directly affects household’s

utility:– Example: Government spending for medical and

educational services.

– νg＜0: Complements Gc↑⇒ ↓⇒C↑– νg＞0: Substitutes Gc↑⇒ ↑⇒C↓– νg = 0: Independent goods Gc↑⇒ →⇒C→

16

Private consumption

Governmentconsumption

2. Model: Effects of government spending II


• Under non‐wasteful government spending: – Fiscal expansions create aggregate demand.– Forward‐looking households will decrease consumption from the negative wealth effect, but also have an incentive to increase consumption from the EC. So, the labor demand does not decrease as much.

– PPC improves private firms’ productivity (a decrease of marginal cost), delivers a decrease in inflation, which loosens monetary tightening policy. Therefore, the “crowd‐out” effect will be weakened.

– As a result, non‐wasteful government spending will help unemployment to be reduced via fiscal stimuli.

17


18

LD

LSwage

labor

U

H L

Increase in aggregate demand

Negative wealth effect

Increasein labor supply

U

ECand PPC

2. Model: Policy rules

• Monetary authority: Taylor rule

• Fiscal authority: Spending reversal rule

– Government debt accumulation decreases government spending.

19

Government debt

3. Estimation method• Parameters estimation via the MCMC：

– Estimating posterior distributions of structural parameters from 200,000 replicates.

• Estimation periods：1980Q2‐2012Q4• Number of estimated parameters：47

• We calibrate parameters difficult to be identified in the estimation referring to the parameters of previous papers.

• 14 observable variables: – output, consumption, investment, government consumption, government investment, bond holdings, wage, unemployment, nominal interest rate, inflation, investment goods inflation, consumption tax, corporate income tax, and labor income tax.

20

3. Estimation methodData:

21

3. Estimation methodMeasurement equation：

– Adding three measurement errors to inflation, wage inflation and investment goods inflation.

22

4. Estimation resultsEdgeworth Complementarities (EC) and Productive Public Capital (PPC):

– EC: νg = ‐0.023 (Iwata 2013, νg = ‐0.416) – PPC: αg = 0.155 (Iwata 2013, αg = 0.046)

Marginal productivity of public capital: α×αg = 0.060

23

4. Estimation resultsPolicy parameters:

Fiscal policy:φgc = 0.289, ρgc = 0.970, φgi = 0.496, ρgi = 0.958

Monetary policy：φπ = 1.532, φy = 0.035, ρR = 0.507

24

4. Estimation results: IRFsIRFs for government investment

Blue：PPC (αg =0.155> 0) Red：w/o PPC (αg = 0)

25

4. Estimation results: IRFs• Effect of government investment shock

– Case of the PPC: • 1% increase in government investment brings an improvement of unemployment by 0.06%.

– An accumulation of PPC leads to relatively lower inflation,

• loosens monetary tightening policy,• delivers relatively higher consumption and investment by decreasing crowd‐out effect.

• As a result, a positive government investment shock enhances output.

• However, there are little differences in the effect of unemployment in both cases.

26

4. Estimation results: IRFsIRFs for government consumption

Blue: EC (νg =‐0.023< 0)，Red: w/o EC (νg = 0)

27

4. Estimation results: IRFs• Effects of government consumption shock

– Crowd‐in effect：• Gov. cons.↑⇒ Private cons. by EC, ↑

– Crowd‐out effect: • Gov. cons.↑⇒ Inflation↑

⇒ Nominal interest rate↑⇒ Real interest rate↑⇒ Private cons. ↓

• The value of νg governs which effect dominates.• νg is estimated as a negative value (about ‐0.02). However, the

absolute value is small. As a result, there is little difference between the case of EC and the case w/o EC. The crowd‐out effect dominates and private consumption decreases. 28

4. Estimation results: IRFsIRFs for neutral technology shock

29

4. Estimation results: IRFs• Response of unemployment to neutral tech. shock

– Temporary increase in unemployment for an increase of productivity. After six quarters, unemployment returns to the steady state.

– In line with the results of GSW. – Mechanism: The roles of real and nominal rigidities.An increase in productivity (a decrease in marginal cost) delivers deflation

• triggers a reduction of real interest rate through monetary easing policy• stimulates aggregate demand from the inter‐temporal substitution effect. • However, consumption and investment cannot respond immediately due to habit persistence and adjustment cost.

• These sluggish responses of aggregate demand require the real wage adjustment to clear the labor market.

• However, the real wage also cannot be adjusted quickly because of nominal rigidities.

• In the end, the temporary excess supply caused by a positive productivity shock is resolved by the reduction of employment. 30

4. Estimation results:Historical decomposition (GDP)

31

‐60%

‐50%

‐40%

‐30%

‐20%

‐10%

0%

10%

20%

30%

40%

50%

Q2‐198

0

Q1‐198

1

Q4‐198

1

Q3‐198

2

Q2‐198

3

Q1‐198

4

Q4‐198

4

Q3‐198

5

Q2‐198

6

Q1‐198

7

Q4‐198

7

Q3‐198

8

Q2‐198

9

Q1‐199

0

Q4‐199

0

Q3‐199

1

Q2‐199

2

Q1‐199

3

Q4‐199

3

Q3‐199

4

Q2‐199

5

Q1‐199

6

Q4‐199

6

Q3‐199

7

Q2‐199

8

Q1‐199

9

Q4‐199

9

Q3‐200

0

Q2‐200

1

Q1‐200

2

Q4‐200

2

Q3‐200

3

Q2‐200

4

Q1‐200

5

Q4‐200

5

Q3‐200

6

Q2‐200

7

Q1‐200

8

Q4‐200

8

Q3‐200

9

Q2‐201

0

Q1‐201

1

Q4‐201

1

Q3‐201

2

Investment specific technological progress shock Trend inflation shock Neutral technology shock

Preference shock Labor supply shock Investment specific technology shock

Government consumption shock Government investment shock Monetary policy shock

Others Output

4. Estimation results:Historical decomposition (GDP)

• Driving forces of output variations:– Neutral technology shock, Invest specific technology (IST) shock, labor supply shock and preference shock.

• Three findings on output variations: – Neutral technology shock is not the key factor explaining the recession during the so‐called lost decade of 1993‐2002.

– Preference shock switches from positive to negative contributions after the bursting of the bubble economy of 1991.

– IST shock is one of the key factors of the depression after the 2000s, including periods of financial crisis of 2007‐2008.

32

4. Estimation results: Historical decomposition (unemployment)

33

‐15%

‐10%

‐5%

0%

5%

10%

15%

Q2‐1980

Q1‐1981

Q4‐1981

Q3‐1982

Q2‐1983

Q1‐1984

Q4‐1984

Q3‐1985

Q2‐1986

Q1‐1987

Q4‐1987

Q3‐1988

Q2‐1989

Q1‐1990

Q4‐1990

Q3‐1991

Q2‐1992

Q1‐1993

Q4‐1993

Q3‐1994

Q2‐1995

Q1‐1996

Q4‐1996

Q3‐1997

Q2‐1998

Q1‐1999

Q4‐1999

Q3‐2000

Q2‐2001

Q1‐2002

Q4‐2002

Q3‐2003

Q2‐2004

Q1‐2005

Q4‐2005

Q3‐2006

Q2‐2007

Q1‐2008

Q4‐2008

Q3‐2009

Q2‐2010

Q1‐2011

Q4‐2011

Q3‐2012




Others Unemployment


• Two main determinants of unemployment after the beginning of the 2000s: – Negative neutral technology shock decreasesunemployment.

– Negative labor supply shock increases unemployment. • A decline of the reservation wage makes labor supply increase which leads to an increase in unemployment.

34


35

‐3.0%

‐2.5%

‐2.0%

‐1.5%

‐1.0%

‐0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Q2‐1980

Q1‐1981

Q4‐1981

Q3‐1982

Q2‐1983

Q1‐1984

Q4‐1984

Q3‐1985

Q2‐1986

Q1‐1987

Q4‐1987

Q3‐1988

Q2‐1989

Q1‐1990

Q4‐1990

Q3‐1991

Q2‐1992

Q1‐1993

Q4‐1993

Q3‐1994

Q2‐1995

Q1‐1996

Q4‐1996

Q3‐1997

Q2‐1998

Q1‐1999

Q4‐1999

Q3‐2000

Q2‐2001

Q1‐2002

Q4‐2002

Q3‐2003

Q2‐2004

Q1‐2005

Q4‐2005

Q3‐2006

Q2‐2007

Q1‐2008

Q4‐2008

Q3‐2009

Q2‐2010

Q1‐2011

Q4‐2011

Q3‐2012

Government consumption shock Government investment shock Unemployment


• Negative co‐movement of government consumption shock with unemployment after the bursting of bubble economy in 1991.

• Since the late 1990s and especially after the financial crisis in 2007‐2008, the positive government consumption shock plays a significant role in the reduction of unemployment by more than 1.5%.

36

5. Conclusion• Findings:

– 1% increase in government consumption reduces unemployment by 0.18%.

– 1% stimulus arising from government investment brings an improvement of unemployment by 0.06%.

– Since the late 1990s and especially after the financial crisis in 2007‐2008, the positive government consumption shock plays a significant role in the reduction of unemployment rate by more than 1.5%.

– The “crowd‐in” channel where fiscal stimuli induce private consumption and investment does not significantly influence unemployment valuations

37

5. Conclusion

• Remaining issues: Empirical side: – Robustness check (various prior distributions, different estimation periods, alternative functional forms of utility, and production function)

– News shockTheoretical side: – Alternative modeling of unemployment

38

Supplements

39

S1. Introduction

40

• How to introduce unemployment into a medium‐scale DSGE model– Embedding the matching friction in the labor market

• e.g. Mayer et al. (2010), Campolmi et al. (2011), Christiano et al. (2013, CTW), Kuo and Miyamoto (2014)

– Some market powers of workers• E.g. Gali (2011), Gali et al. (2012, GSW)

S1. Introduction

• The “effectiveness” of government spending also matters: – Introducing rule‐of‐thumb households

• e.g. Mayer et al. (2010)

– Introducing non‐wasteful government spending: • Complementarity between government consumption and private consumption (Edgeworth complementarities)

• Improvement of private firms’ productivities by accumulating public capital (Productive Public capital)

41

S2. Model: Firms• Intermediate goods firms’ price setting

– Each intermediate good firm produces a differentiated good, and has some market power.

– Under the nominal rigidity (price revision probability: 1 ‐ ξp), she decide her price at the current period so as to maximize the discounted present value of her profit.

– The firms who cannot set their price index their prices with the previous inflation rate (inflation persistency).

42

S2. Model: Firms• FOCs of intermediate goods firms：

New Keynesian Phillips Curve (price)：

– Taking account for “future” marginal benefit and “future” marginal cost since there is a possibility that they cannot revise her future price, firms decide their current price. As a result, NKPC which describes inflation dynamics includes the forward‐looking term. 43

S2. Model: Firms• Capital producing firms

• Capital producing firms purchase effective capital uK at price Pk, produces homogenous capital goods bundling this with public capital Kg, and sells them to the intermediate goods firms at price Rk.

• FOC:

• pk = rk , if αg = 0.44

S2. Model: Households• FOCs of households：

– Marginal utility on consumption：

– Euler equation on consumption :

– Stochastic discount factor:

– Inter‐temporal consumption smoothing condition: Government consumption affects the Euler equation．In case of the Edgeworth complementarities, an increase of government consumption raises marginal consumption , which leads to the increase of private consumption. 45

S2. Model: Structural shocks• 15 structural shocks

46

S3. Estimation method• Calibrated parameters

– Calibrated parameters using sample means and the estimation result in the previous papers.

47

S4. Estimation resultsNominal rigidities:

– Price: ξp = 0.560 (Iwata 2013, ξp = 0.656)– Wage: ξw = 0.489 (GSW 2011, ξw = 0.470)

48

S4. Estimation results: IRFsIRFs for monetary easing policy

49

S4. Estimation results: IRFs

• Policy coordination matters:– 1% monetary easing policy brings an improvement in unemployment by 0.15% (and vice versa).

– Both government consumption and investment are demand shocks since these shocks generate a positive co‐movement of output with inflation. Inflation caused by fiscal stimuli triggers monetary tightening policy, which decreases unemployment.

50

S4. Estimation results: Historical decomposition (inflation)

51

‐8%

‐6%

‐4%

‐2%

0%

2%

4%

6%

8%

10%Q2‐1980

Q1‐1981

Q4‐1981

Q3‐1982

Q2‐1983

Q1‐1984

Q4‐1984

Q3‐1985

Q2‐1986

Q1‐1987

Q4‐1987

Q3‐1988

Q2‐1989

Q1‐1990

Q4‐1990

Q3‐1991

Q2‐1992

Q1‐1993

Q4‐1993

Q3‐1994

Q2‐1995

Q1‐1996

Q4‐1996

Q3‐1997

Q2‐1998

Q1‐1999

Q4‐1999

Q3‐2000

Q2‐2001

Q1‐2002

Q4‐2002

Q3‐2003

Q2‐2004

Q1‐2005

Q4‐2005

Q3‐2006

Q2‐2007

Q1‐2008

Q4‐2008

Q3‐2009

Q2‐2010

Q1‐2011

Q4‐2011

Q3‐2012




Others Inflation rate

S4. Estimation results: Historical decomposition (inflation)

• Negative contributions of the following three shocks caused serious deflation after the 1990s.– IST shock

• Interpreted as the negative financial shock, following Justiniano and Primiceri (2008).

– Preference shock• Negative demand shock

– Labor supply shock• Negative labor supply shock causes the reduction of reservation wage, which leads to the decrease in marginal cost.

52

53

‐6%

‐4%

‐2%

0%

2%

4%

6%

Q2‐1980

Q1‐1981

Q4‐1981

Q3‐1982

Q2‐1983

Q1‐1984

Q4‐1984

Q3‐1985

Q2‐1986

Q1‐1987

Q4‐1987

Q3‐1988

Q2‐1989

Q1‐1990

Q4‐1990

Q3‐1991

Q2‐1992

Q1‐1993

Q4‐1993

Q3‐1994

Q2‐1995

Q1‐1996

Q4‐1996

Q3‐1997

Q2‐1998

Q1‐1999

Q4‐1999

Q3‐2000

Q2‐2001

Q1‐2002

Q4‐2002

Q3‐2003

Q2‐2004

Q1‐2005

Q4‐2005

Q3‐2006

Q2‐2007

Q1‐2008

Q4‐2008

Q3‐2009

Q2‐2010

Q1‐2011

Q4‐2011

Q3‐2012

Monetary policy shock Unemployment

S4. Estimation results: Historical decomposition (unemployment)

introducing unemployment and non- wasteful government ... · introducing unemployment and...

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