Open seminar "A real-business-cycle model with efficiency wages and a government sector: the case of Bulgaria"

Thursday, 29. March 2018 - 11:00 to 12:30
Eesti Pank Museum (Estonia pst 11)

At 11-12:30 in the Eesti Pank Museum: open seminar by Aleksandar Vasilev from Sofia University on a real-business-cycle model with efficiency wages and a government sector: the case of Bulgaria. The seminar will be held in English.

A Real-Business-Cycle Model with Efficiency Wages and a Government Sector: The Case of Bulgaria
Aleksandar Vasilev

The standard real business cycle model, e.g. Kydland and Prescott (1982) and Long and Plosser (1983), was shown to be unable to capture the dynamics in the labor markets in the US. For Bulgaria, Vasilev (2009) documented a similar failure for wage and employment fluctuations. Most of those earlier studies have tried to explain the mismatch with the modeling choice assuming perfect information and market clearing, and the absence of involuntary unemployment. Bulgaria, however, as many other Eastern European countries as well, exhibits a significant rate of involuntary unemployment, which was due to the process of structural transformation. In other words, being out of job is not an optimal choice, but rather represents an inefficient outcome, as it produces a waste of non-storable labor resources.

Modeling unemployment as inefficiency requires a departure from the Walrasian (market-clearing) models of labor markets. In other words, only when certain imperfections in labor market are present in the model, can involuntary unemployment appear. Since we are interested in studying the cyclical behavior of the labor market, we take those seriously. In this paper we investigate the quantitative importance of efficiency wages of no-shirking type in explaining business cycle fluctuations in Bulgarian labor markets. This is done by augmenting a relatively standard real business cycle model a la Long and Plosser (1983) with unobservable workers effort by employers and efficiency wage contracts as in Shapiro and Stiglitz (1984), as well as through the inclusion of a detailed government sector. This imperfection in labor markets introduces a strong internal transmission mechanism that allows the model framework to capture the business cycles in Bulgarian data better than earlier models. The model performs well vis-a-vis data, especially along the labor market dimension, and in addition dominates both the market-clearing labor market framework featured in the standard RBC model, e.g Vasilev (2009).

Overall, as in the case with the search-and-matching model calibrated for Bulgaria in Vasilev (2016), the model with efficiency wages provides a tractable general-equilibrium setup which also generates persistence in output and both employment and unemployment, and is able to respond to the criticism in Nelson and Plosser (1992), Cogley and Nason (1995) and Rotemberg and Woodford (1996), who argue that RBC models generally do not have a strong internal propagation mechanism (besides the strong persistence in the TFP process).