A Macroeconomic Model for the Evaluation of Labor Market Reforms

44 Pages Posted: 25 Aug 2010

See all articles by Tom Krebs

Tom Krebs

University of Mannheim

Martin Scheffel

ZEW – Leibniz Centre for European Economic Research

Date Written: 2010


We develop a tractable macroeconomic model with employment risk and labor market search in order evaluate the effects of labor market reform on unemployment, growth, and welfare. The model has a large number of risk-averse households who can invest in risk-free physical capital and risky human capital. Unemployed households receive unemployment benefits and decide how much search effort to exert. We present a theoretical characterization result that facilitates the computation of equilibria substantially. We calibrate the model to German data and use the calibrated model economy to simulate the macroeconomic effects of the German labor market reforms of 2005 and 2006 (Hartz Reforms). We find that the 2005 reform had large employment effects: the equilibrium unemployment rate has been reduced by approximately 1.1 percentage points from 7.5 to 6.4 percent. Moreover, the drop in unemployment has led to substantial output gains. Finally, employed and short-term unemployed households experienced significant welfare gains, whereas the long-term unemployed have lost in welfare terms. The effects of the 2006-reform are qualitatively similar, but quantitatively much smaller. We also show that the social welfare maximizing replacement rate is lower than the current (post-reform) replacement rate in Germany. However, implementing the optimal unemployment benefit system generates only small welfare gains.

Keywords: Dynamic General Equilibrium, Heterogenous Agents, Human Capital, Labor Market Search, Unemployment Insurance, German Labor Market Reform

JEL Classification: E24, E60, J64, J65

Suggested Citation

Krebs, Tom and Scheffel, Martin, A Macroeconomic Model for the Evaluation of Labor Market Reforms (2010). ZEW - Centre for European Economic Research Discussion Paper No. 10-050. Available at SSRN: https://ssrn.com/abstract=1663654 or http://dx.doi.org/10.2139/ssrn.1663654

Tom Krebs

University of Mannheim

United States

Martin Scheffel (Contact Author)

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034

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