Market Reforms at the Zero Lower Bound

Abstract

This paper studies the impact of product and labor market reforms when the economy facesmajor slack and a binding constraint on monetary policy easing. such as the zero lowerbound. To this end, we build a two-country model with endogenous producer entry, labormarket frictions, and nominal rigidities. We find that while the effect of market reformsdepends on the cyclical conditions under which they are implemented, the zero lower bounditself does not appear to matter. In fact, when carried out in a recession, the impact of reformsis typically stronger when the zero lower bound is binding. The reason is that reforms areinflationary 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 reformsas exogenous reductions in price and wage markups, our analysis shows that there is nosimple across-the-board relationship between market reforms and the behavior of realmarginal costs. This significantly alters the consequences of the zero (or any effective) lowerbound on policy rates.

Keywords: Employment protection; Monetary policy; Producer entry; Product market regulation; Structural reforms; Unemployment benefits; Zero lower bound, Employment protection, Monetary policy, Producer entry, Product market regulation, Structural reforms, Unemployment benefits, Zero lower bound, Monetary Policy (Targets, Instruments, and Effects), Open Economy Macroeconomics, Unemployment: Models, Duration, Incidence

JEL Classification: E24, E32, E52, F41, J64