The impact of selected structural reforms:

Adjustment speed and distributional effects

Annabelle MourouganeLukas Vogel

OECD Economics Department

14th DUBROVNIK ECONOMIC CONFERENCE

Introduction

• Good understanding of the long-term effects of structural reforms

• Little is known about short-term effects of reforms

• Crucial from a political economy point of view

Roadmap

• Tools used in the paper• Delays of adjustment• Effects of existing market rigidities

on the speed of adjustment• Interactions with monetary policy

and international spillovers• Distributional effects of reforms

Tools

A set of complementary tools

• Data on institutions provides us insights on ex-post effects of reforms

• Models are useful for ex-ante assessments Macro-economic neo-Keynesian models DGE model

Delays of adjustment

The equilibrium unemployment rate and the contribution of institutions in the European Union

Note: The sample includes the 20 countries examined in Bassainini and Duval (2006) except Germany, Finland and Sweden.

5

6

7

8

9

10

1995 1996 1997 1998 1999 2000 2001 2002 2003

Equilibrium unemploymentper cent

0

1

2

3

4

5

1995 1996 1997 1998 1999 2000 2001 2002 2003

Replacement ratepercentage point

5

6

7

8

9

10

1995 1996 1997 1998 1999 2000 2001 2002 2003

Tax wedgepercentage point

0

1

2

3

4

5

1995 1996 1997 1998 1999 2000 2001 2002 2003

Product market regulationpercentage point

The impact of structural reforms is gradual

Correlation [(INSTt-i),NAIRUt –NAIRUt-i)]

-0.1

-0.05

0

0.05

0.1

0.15la

g 1

lag

2

lag

3

lag

4

lag

5

lag

6

lag

7

lag

8

lag

9

lag

10

Average replacement ratio

years

-0.1

-0.05

0

0.05

0.1

0.15

lag

1

lag

2

lag

3

lag

4

lag

5

lag

6

lag

7

lag

8

lag

9

lag

10

Tax wedge

years

-0.1

-0.05

0

0.05

0.1

0.15

lag

1

lag

2

lag

3

lag

4

lag

5

lag

6

lag

7

lag

8

lag

9

lag

10

EPL

years

-0.1

-0.05

0

0.05

0.1

0.15

lag

1

lag

2

lag

3

lag

4

lag

5

lag

6

lag

7

lag

8

lag

9

lag

10

Product market regulation

years

Impact of existing market rigidities

Modelling rigidities in the DGE model

• Employment and price adjustment costs

• Quadratic forms

Employment:

Price:

Hiring and firing and price adjustment costs are found to have a limited effects on the speed…

Effect of a 1 percentage point income tax rate cut(Change compared to baseline)

This result holds for a number of reforms

Cut in social security contributions

Cut in the benefit replacement rate

And is robust to the way the labour market is modelled

Search-and-matching model(Change compared to baseline)

Interaction with monetary policy

Monetary policy can speed up the adjustment in the United States…

Impact on production of a one percentage point decline in the NAIRU

(Change compared to baseline)

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

0 10 20 30 40 50 60 70 80

United States

without monetary policy reactionwith monetary policy reaction

quarters

%

… but less so in the euro area…

Impact on production of a one percentage point decline in the NAIRU

(Change compared to baseline)

-0.2

0

0.2

0.4

0.6

0.8

0 10 20 30 40 50 60 70 80

Euro area

without monetary policy reactionwith monetary policy reaction

quarters

%

… even with an alternative monetary policy reaction

Impact of a one percentage point decline in the NAIRU

0

0.2

0.4

0.6

0.8

1

1.2

0 10 20 30 40 50 60 70 80

Euro area real GDP(difference from baseline)

Taylor rule (0.5, 0.5) Inflation targeting

Taylor rule (0.2, 0.8) US real GDP with Taylor rule (0.5, 0.5)

quarters

%

… and even less so in individual euro area countries

Example of France

Impact on production of a one percentage point decline in the NAIRU

(Change compared to baseline)

0

0.2

0.4

0.6

0.8

1

0 10 20 30 40 50 60 70 80

France

without monetary policy reactionwith monetary policy reaction

quarters

%

International spillovers are very small

-0.2

0

0.2

0.4

0.6

0.8

0 10 20 30 40 50 60 70 80

Real GDP

United States Euro area

quarters

%

Impact of a one percentage point decline in the U.S. NAIRU

(Change compared to baseline)

Distributional effects of reforms

Distributional effects of reforms

Introduction of two types of households in the DGE model:

Fully optimising households: unlimited access to financial markets, fully optimise their consumption decisions

Liquidity-constrained households: can only consume their disposable income at each period

Potential short-term costs of structural reforms

Income tax cut Replacement rate cut Social contribution cut

Effects of a budgetary compensation scheme

Cut in the benefit replacement rate(Change compared to baseline)

Concluding remarks

• The impact of structural reforms is gradual and takes years to materialise.

• Employment and price adjustment costs are found to have a very small impact on adjustment speed.

• Monetary policy can fasten significantly the adjustment process but mostly in the United States.

• Structural reforms can have different distributional implications.