Author: Matteo Cacciatore, Mr. Romain A Duval, Giuseppe Fiori, and Mr. Fabio Ghironi
This paper studies the impact of product and labor market reforms when the economy faces
major slack and a binding constraint on monetary policy easing. such as the zero lower
bound. To this end, we build a two-country model with endogenous producer entry, labor
market frictions, and nominal rigidities. We find that while the effect of market reforms
depends on the cyclical conditions under which they are implemented, the zero lower bound
itself does not appear to matter. In fact, when carried out in a recession, the impact of reforms
is typically stronger when the zero lower bound is binding. The reason is that reforms are
inflationary in our structural model (or they have no noticeable deflationary effects). Thus,
contrary to the implications of reduced-form modeling of product and labor market reforms
as exogenous reductions in price and wage markups, our analysis shows that there is no
simple across-the-board relationship between market reforms and the behavior of real
marginal costs. This significantly alters the consequences of the zero (or any effective) lower
bound on policy rates.
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