Divergence in Labor Market Institutions and International Business Cycles

by Raquel Fonseca Benito, Lise Patureau, Thepthida Sopraseuth

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This paper investigates the sources of business cycle comovement within the New Open Economy Macroeconomy framework. It sheds new light on the business cycle comovement issue by examining the role of cross-country divergence in labor market institutions. The authors first document stylized facts supporting that heterogeneous labor market institutions are associated with lower cross-country GDP correlations among OECD countries. They then investigate this fact within a two-country dynamic general equilibrium model with frictions on the good and labor markets. On the good-market side, they model monopolistic competition and nominal price rigidity. Labor market frictions are introduced through a matching function à la Mortensen and Pissarides (1999). Their conclusions disclose that heterogenous labor market institutions amplify the crosscountry GDP differential in response to aggregate shocks. In quantitative terms, they contribute to reduce cross-country output correlation, when the model is subject to real and/or monetary shocks. Their overall results show that taking into account labor market heterogeneity improves their understanding of the quantity puzzle.

The research in this report was made possible by the NIA funded RAND Center for the Study of Aging and the NICHD funded RAND Population Research Center.

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