MARKET BEHAVIOUR AND MACROECONOMIC MODELLING

Market Behaviour and Macroeconomic Modelling

Edited by

Steven Brakman Associate Professor University ofGroningen The Netherlands

Hans van Ees Professor of Economic Theory and Economic Education University ofGroningen The Netherlands

and

Simon K. Kuipers Professor of Macroeconomic and Monetary Theory University ofGroningen The Netherlands

First published in Great Britain 1998 by MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 6XS and London Companies and representatives throughout the world

A catalogue record for this book is available from the British Library.

ISBN 978-1-349-26734-7 ISBN 978-1-349-26732-3 (eBook) DOI 10.1007/978-1-349-26732-3

First published in the United States of America 1998 by ST. MARTIN'S PRESS, INC., Scholarly and Reference Division, 175 Fifth Avenue, New York, N.Y. 10010

ISBN 978-0-312-21493-7 Library of Congress Cataloging-in-Publication Data Market behaviour and macroeconomic modelling I edited by Steven Brakman, Hans van Ees, Simon K. Kuipers. p. em. Includes bibliographical references and index. ISBN 978-0-312-21493-7 (cloth) I. Macroeconomics-Econometric models. 2. Free enterprise. 3. Labor market. I. Brakman, Steven. II. Van Ees, Hans, 1955-111. Kuipers, S. K. (Simon Klaas) HB 172.5.M365 1998 339'.01'5118---dc21 98-13604

CIP

Selection and editorial matter © Steven Brakman, Hans van Ees and Simon K. Kuipers 1998 Chapter 6 © Hans van Ees, Harry Garretsen, Leo de Haan and Elmer Sterken 1998 Chapters 1-5,7-14 ©Macmillan Press Ltd 1998 Softcover reprint of the hardcover 1st edition 1998

All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

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This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources.

10 9 8 7 6 5 4 07 06 05 04 03 02 01

3 2 I 00 99 98

Contents List of'Rlbles List of Figures Preface List of Contributors

Part I Imperfect competition (A)

The Multiplier in an Economy with Monopolistic Output Markets and Competitive Labour Markets Marta Aloi, Huw Dixon and Phillip Lawler

2 Imperfect Competition and Aggregate Price Equations Ate Nieuwenhuis

Part ll Imperfect competition (B)

3 A Critical Assessment of the Role of Imperfect Competition in Macroeconomics Dennis W. Carlton

4 An International Comparative Analysis of the State Competition Robert C. G. Haffner and Peter A. G. van Bergeijk

Part ill Financial market imperfections

5 The Importance of Credit for Macroeconomic Activity: Identification through Heterogeneity Simon Gilchrist and Egon Zakrajsek

6 Investment and Debt Constraints: Evidence from Dutch Panel Data Hans van Ees, Harry Garretsen, Leo de Haan and Elmer Sterken

Part IV Labour market imperfections

7 Sticky Consumption and Rigid \\ages Tore Ellingsen and Steinar Holden

8 Structural Aspects of the Labour Markets of Five OECD Countries Geert Ridder, Niels de Usser and Gerard van den Berg

v

vii ix

xiii XV

3

41

73

105

129

159

183

201

Vl Contents

Part V Short-run rigidities

9 Short-run Rigidities and Long-run Equilibrium in Large-scale Macroeconometric Models Keith B. Church, Peter R. Mitchell and Kenneth E Ubllis

10 High and Low Skilled Labour in a Macroeconometric Model of the Netherlands D.P. Broer, D.A. G. Draper, A. Houweling, EH Huizinga and P.A. de Jongh

Part VI Intertemporal modelling

11 Uses and Limitations ofPublic Debt Willem H Buiter and Kenneth M Kletzer

12 Capital Income Taxation and the Sustainability of Permanent Primary Deficits Harald Uhlig

Part VII Policy implications

13 Policy Implications of Endogenous Growth Models Jarig van Sinderen and Theo J.A. Roelandt

14 Modelling Government Investment and Economic Growth on a Macro Level: A Review Jan-Egbert Sturm, Geranl H Kuper and Jakob de Haan

Index

221

243

275

309

341

359

407

List of lllbles 2.1 Reduced-form elasticities of MINI, 'Y2 = 8 f = 0 65 2.2 Reduced-form elasticities of MINI, 'Y2 = 81 = 0.5 65 2.3 Reduced-form elasticities ofMINI, 'Y2 = 81 = 1.0 66

4.1 Summary of structure, conduct and performance indicators of competition 109

4.2 Conduct indicators for selected OECD economies 117 4.3 Performance indicators for selected OECD economies 118 4.4 Overall ranking of countries according to four different

indicators 119 4.5 Macroeconomic benefits of increasing competition 120

5.1 Short-term debt and aggregate economic activity, results from a bivariate system 151

5.2 Short-term debt and aggregate economic activity, results from a multivariate system 151

5.3 The effect of the federal funds rate on S-T debt 152 5.4 The effect of cash flow on inventory investment 152 5.5 The effect of cash flow on inventory investment:

asymmetric effects over the business cycle 153

6.1 Summary statistics for Dutch manufacturing, 1983-1992 168 6.2 GMM-estimates of the Euler investment equation 169 6.3 Factor pattern matrix 172 6.4 GMM-estimates of debt-constraint augmented Euler

investment equation: subsamples 173

8.1 Average, standard deviation of monthly wage and minimum wage in local currency 1990/1991 215

8.2 Offer arrival rate and job destruction rate per month 216 8.3 Unemployment rate: frictional and structural 216 8.4 Mean and standard deviation of productivity in active

markets (national currency), average monopsony index, and decomposition of wage variation 217

vii

viii List of Tables

9.1 Government expenditure simulation: increase of £2bn (1990 prices) in procurement spending 229

9.2 Productivity shock: increase in level of employment of 1 per cent 236

10.1 Price elasticities and elasticities of technological change 255 10.2 Determinants of long-term employment 256 10.3 Estimation results of the wage equations 261 10.4 Cumulative production structure for 1992, billions of

guilders 263 10.5 Estimation results for price equations in CPS, t-statistics

in parentheses 264 10.6 Cumulated effects of an increase in world trade by 1 per

cent 266 10.7 Cumulated effects of a minimum wage reduction and

related benefits by 1 per cent 267 10.8 Cumulated effects of an increase in the labour supply of

high and low-skilled workers by 10 000 persons each 268

13.1 Technology related sources of growth in new growth models 343

13.2 Determinations of long-run elasticities with respect to human capital 351

13.3 The four regimes of MESEMET 353 13.4 Impact of four policy instruments on production growth

and employment for two macroeconomic regimes (policy shocks of 0,1% NI) in the long run 354

14.1 Estimation of the production elasticity of public capital based on production functions 384

14.2 Studies using the behavioral approach 387 14.3 A summary ofVAR studies 395 14.4 A summary of cross country growth regressions 395 14.5 A summary of cross states growth regressions 396 14.6 Estimates of aggregate production functions in levels for

the Netherlands, 1953-1991 398 14.7 Estimates of aggregate production functions in first

differences for the Netherlands, 1954-1991 399

List of Figures 1.1 The firm in long-run equilibirum with free entry 11 1.2 Long-run equilibrium 13 1.3 Short-run equilibrium 16 1.4 Income expansion paths 25 1.5 The PPF for consumption and leisure as g varies 26 1.6 The equilibria compared 27 1.7 The multipliers compared 28 1.8 The long-run production possibility frontiers 29 1.9 The long-run multipliers compared 29 1.10 The short-run and long-run multipliers compared when

J.L>O 30 1.11 The short-run and long-run multipliers compared when

J.L>O 31 1.12 The Walrasian (A) and imperfectly competitive (B)

equilibria 34 1.13 The Walrasian multiplier (A - A') and the imperfectly

competitive multiplier (B - B') 35

3.1 Equilibrium in a market with monopolistic competition 76 3.2 Deadweight loss 77 3.3 Per capita GDP vs. capital-labour ratio, 1990 84 3.4 Per capita GDP vs. intellectual property rights, 1990 85 3.5 Intellectual property rights vs. capital-labour ratio, 1990 85 3.6 Capital-labour ratio vs. human capital per capita, 1990 86 3.7 Per capita GDP growth vs. intellectual property rights

1960-90 86 3.8 Intellectual property rights vs. per capita higher education

R&D expenditures 87 3.9 Relationship of durable goods to GDP 92 3.10 Ratio of new car price to four year used car price for the

Cadillac Sedan Deville, 1969-1995 94

5.1 The premium for external funds 133 5.2 The premium for external funds. Impact of a rise in

demand 133 5.3 The premium for external funds. A rise in the riskless

interest rate 134 5.4 The relative importance of fmancially constrained firms 148

ix

X List of Figures

6.1 Firm-specific interest rate premium 171 6.2 Corporate debt rate for all and low-payout firms 175

7.1 The actual utility is given by the best of the two alternatives 188

7.2 The chosen wage is increasing in labour demand, with discrete positive jumps 193

7.3 Quantity of durables causes wage moderation or aggresiveness 193

8.1 Earnings and wage offer density. 211

9.1 Inflation-unemployment responses 227 9.2 Inflation-unemployment responses 228 9.3 Inflation-unemployment responses 231 9.4 Inflation-unemployment responses 232 9.5 Inflation-unemployment responses 233 9.6 Inflation-unemployment responses 233 9.7 Inflation-unemployment responses 237 9.8 Labour productivity over time 239 10.1 Overview of the model 247 10.2 The labour market 251 10.3 Development of employment and wages by skill level 252 11.1 Equilibrium 290 11.2 After-tax rate of interest exceeds long-run natural rate of

growth 294 12.1 The capital income tax rate r in the case of a fixed capital

stock in dependence of the equilibrium return R 320 12.2 The annualized capital income tax rate 1- {1- r) 1125

in the case of a fixed capital stock in dependence of the annualized equilibrium return R1125 321

12.3 The minimal capital income tax rate sustaining the permanent primary deficit ayt 322

12.4 The capital income tax rate r in the case of a variable capital stock in dependence of the annualized equilibrium returnR 326

12.5 Equilibrium output in dependence of the annualized equilibrium return R in case of a variable capital stock 327

12.6 Equilibrium welfare of the two-period lived as well as the initially old in dependence of the annualized equilibrium return R in case of a variable capital stock 329

List of Figures x1

12.7 W:1fare-maximizing capital income tax rate in dependence of the primary deficit ayt in the case of a variable capital stock 329

12.8 The capital income tax rate T in the case of a variable capital stock in dependence of the annualized equilibrium return R 330

12.9 Equilibrium output in dependence of the annualized equilibrium return R in case of a variable capital stock. 330

12.10 Equilibrium welfare of the two-period lived as well as the initially old in dependence of the annualized equilibrium return R in case of a variable capital stock 331

12.11 \\elfare-maximizing capital income tax rate in dependence of the primary deficit ayt in the case of a variable capital stock 331

14.1 Public investment as a share of GOP between 1970 and 1992 360

Preface This book contains the papers of the workshop Market Behaviour and Macro­economic Modelling that was held at the University ofGroningen, the Nether­lands on June 6-7, 1996. The workshop was jointly organized by the Centre for Economic Research (a research group of economists aff"uiated with the University of Groningen and the University ofTwente ), the Netherlands Bu­reau for Economic Policy Analysis (CPB) and the Ministry of Economic Affairs. The aim was to bring together economic scholars and economists engaged in policy formulation to discuss the implications of market imper­fections for macroeconomic modelling from the perspective of both eco­nomic theory and policy. The papers in this volume deal with imperfections in commodity markets, capital markets and labour markets, as well as with their implications for economic policy design. In line with recent economic theory, all papers reveal the need for a sound theoretical framework. At the same time the various studies illustrate that a uniform microfoundation for market imperfections is still lacking in macro models, which consequently leads to a rather diverse range of models, sometimes with different implica­tions for economic policy. This does not necessarily imply the existence of a weakness within this line of research; in a world as diverse as ours it may be a blessing in disguise that one can choose from many models with which to analyse the problems at hand. What to include in empirical models is highly dependent on the specific (policy) problem under consideration. Both the art of modelling and the skill of the researcher resolves this paradox, allowing the construction of sound theoretical models that produce interesting out­comes. There is no need to say that this is a difficult task. The papers in this volume illustrate both the progress that has been made in this area, as well the work that still has to be done. We would like to express our gratitude to Pe­ter van Bergeijk, at that time at the Ministry of Economic Affairs and Ruud Okker of the Netherlands Bureau for Economic Policy Analysis for their help in the organization of the workshop. Similarly, Lies Baars and Nanne Brunia provided great organizational assistance and last but not least, we ac­knowledge the superb TEJC-editing skills ofThijs Knaap. Finally, we thank the Royal Netherlands Academy of Sciences, the University of Groningen, and the Netherlands Central Bank for making this second CCSO workshop possible.

Groningen, August 1997

xiii

S. Brakman H. vanEes

S.K. Kuipers

List of Contributors

M. Aloi

A. van den Berg

P.A.G. van Be~geijk

S. Brakman

D.P. Broer

W.H. Buiter

D.W. Carlton

K.B. Church

H.D. Dixon

D.A.G. Draper

H. vanEes

T. Ellingsen

H. Garretsen

S.G. Gilchrist

L. deHaan

J. de Haan

R.C.G. Haffner

S. Holden

University of York York Free University Amsterdam Netherlands Central Bank Amsterdam University of Groningen Groningen CPB - Netherlands Bureau for Economic Policy Analysis, The Hague Cambridge University Cambridge University of Chicago Chicago University ofWcuwick Coventry University of York York CPB - Netherlands Bureau for Economic Policy Analysis, The Hague University of Groningen Groningen University of Oslo Oslo University ofNijmegen Nijmegen Boston University Boston Netherlands Central Bank Amsterdam University of Groningen Groningen Ministry of Economic Affairs The Hague University of Oslo Oslo

XV

XVl

A. Houweling

F.H. Huizinga

P.A. de Jongh

K. Kletzer

S.K. Kuipers

G.H.Kuper

P. Lawler

P.R Mitchell

A. Nieuwenhuis

G. Ridder

T.J .A. Roelandt

J. van Sinderen

E. Sterken

J.-E. Sturm

H. Uhlig

N. de Visser

K.F. \\allis

E. Zakrajsek

List of Contributors

CPB - Netherlands Bureau for Economic Policy Analysis, The Hague CPB - Netherlands Bureau for Economic Policy Analysis, The Hague CPB - Netherlands Bureau for Economic Policy Analysis, The Hague University of California Santa Cruz University of Groningen Groningen University of Groningen Groningen University of York York University of \\arwick Coventry CPB - Netherlands Bureau for Economic Policy Analysis, The Hague Free University Amsterdam Ministry of Economic Affairs The Hague Ministry of Economic Affairs The Hague University of Groningen Groningen University of Groningen Groningen CentER, Tilburg University Til burg Free University Amsterdam University of\\arwick Coventry Federal Reserve Board \\ashington