Discussion of Cacciatore, Fiori and Ghironi s Market Deregulation and Optimal Monetary Policy in a Monetary Union

Discussion of Cacciatore, Fiori and Ghironi s Market Deregulation and Optimal Monetary Policy in a Monetary Union Andrea Ferrero University of Oxford European Central Bank Conference on Heterogeneity in Currency Areas and Macroeconomic Policies Frankfurt November 29, 213

The Call for Structural Reforms Very timely paper!...the biggest problem we have for growth in Europe is the problem of lack of competitiveness that has been accumulated in some of our Member States, and we need to make the reforms for that competitiveness....to get out of this situation requires...structural reforms, because there is an underlying problem of lack of competitiveness in some of our Member States. José Manuel Durão Barroso President of the European Commission Closing Remarks following the State of the Union 212 Strasbourg, September 12, 212 Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 2 / 17

Lack of Competitiveness 4.6 Labor market efficiency index (1 = min, 7 = max) 4.4 4.2 4 3.8 3.6 3.4 3.2 GRE POR PERIPHERY ITA IRE FIN CORE FRA SPA AUTGER BEL NET 3 3.5 4 4.5 5 5.5 6 Product market efficiency index (1 = min, 7 = max) Source: World Economic Forum (211) Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 3 / 17

This Paper Takes a Step Back No crisis, but sensible model of entry/exit and labor market frictions Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 4 / 17

This Paper Takes a Step Back No crisis, but sensible model of entry/exit and labor market frictions Deregulation Reduction of Entry costs (product market) Unemployment benefits and employment protection (labor market) Study monetary policy in deregulation scenario Optimal (Ramsey) Historical (Taylor) rule Results: Optimality entails 1 Inflation target > and departure from Taylor rule with high regulation 2 Response to deregulation more expansionary than implied by Taylor rule 3 Gains from international reform coordination Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 4 / 17

Outline 1 Perspective 2 Model 3 Current account effects 4 Monetary policy Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 5 / 17

1. Perspective: Crisis or No Crisis? Debate on structural reforms motivated by crisis... Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 6 / 17

1. Perspective: Crisis or No Crisis? Debate on structural reforms motivated by crisis......but authors want to steer clear of crisis bit Still interesting to learn about properties of reforms in normal times Personally, I d really like to know about reforms during crisis in this framework Eggertsson, Ferrero and Raffo (213): Reforms in a crisis can be bad Limitation: Dixit-Stiglitz monopolistic competition in goods and labor markets Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 6 / 17

1. Perspective: Crisis or No Crisis? Debate on structural reforms motivated by crisis......but authors want to steer clear of crisis bit Still interesting to learn about properties of reforms in normal times Personally, I d really like to know about reforms during crisis in this framework Eggertsson, Ferrero and Raffo (213): Reforms in a crisis can be bad Limitation: Dixit-Stiglitz monopolistic competition in goods and labor markets Our view: Entry likely to play major role in medium/long run Short-run effects likely to impact primarily incumbents But long-run income effects play a role for short-run response Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 6 / 17

Long-Run Income Effect and Short-Run Adjustment AD: Ŷ S = Ŷ L }{{} AS: π S = = ψω L + σ 1 µ 1 µ π S + σ 1 1 µ r S e κ 1 µβ ŶS + κψ 1 µβ ω S AD AS S A C B YS Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 7 / 17

Long-Run Income Effect and Short-Run Adjustment AD: Ŷ S = Ŷ L }{{} AS: π S = = ψω L + σ 1 µ 1 µ π S + σ 1 1 µ r S e κ 1 µβ ŶS + κψ 1 µβ ω S AD AS πs A B C YS Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 7 / 17

2. Model: Product Market Deregulation Only one sector, all goods are tradable, no idiosyncratic productivity Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 8 / 17

2. Model: Product Market Deregulation Only one sector, all goods are tradable, no idiosyncratic productivity Debate on reforms: More entry or reallocation across sectors? Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 8 / 17

2. Model: Product Market Deregulation Only one sector, all goods are tradable, no idiosyncratic productivity Debate on reforms: More entry or reallocation across sectors? Estimates of product market markups (OECD, 25) Markup Estimates Italy and Spain France and Germany Aggregate 1.36 1.25 Manufacturing 1.17 1.14 Services 1.48 1.33 Periphery not much less competitive in tradable sector Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 8 / 17

2. Model: Product Market Deregulation Only one sector, all goods are tradable, no idiosyncratic productivity Debate on reforms: More entry or reallocation across sectors? Estimates of product market markups (OECD, 25) Markup Estimates Italy and Spain France and Germany Aggregate 1.36 1.25 Manufacturing 1.17 1.14 Services 1.48 1.33 Periphery not much less competitive in tradable sector Competitiveness gap in non-tradable sector Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 8 / 17

2. Model: Product Market Deregulation Only one sector, all goods are tradable, no idiosyncratic productivity Debate on reforms: More entry or reallocation across sectors? Estimates of product market markups (OECD, 25) Markup Estimates Italy and Spain France and Germany Aggregate 1.36 1.25 Manufacturing 1.17 1.14 Services 1.48 1.33 Periphery not much less competitive in tradable sector Competitiveness gap in non-tradable sector Policy recommendation: For given entry, switch resources to tradable sector And/or lower barriers to entry in non-tradable sector Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 8 / 17

2. Model: Product Market Deregulation Only one sector, all goods are tradable, no idiosyncratic productivity Debate on reforms: More entry or reallocation across sectors? Suggestion: 1 Introduce idiosyncratic productivity shocks and export costs Endogenous tradability (Ghironi and Melitz, 25) Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 9 / 17

2. Model: Product Market Deregulation Only one sector, all goods are tradable, no idiosyncratic productivity Debate on reforms: More entry or reallocation across sectors? Suggestion: 1 Introduce idiosyncratic productivity shocks and export costs Endogenous tradability (Ghironi and Melitz, 25) 2 Implement structural reforms: What happens? More entry Non-tradable sector more competitive Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 9 / 17

2. Model: Product Market Deregulation Only one sector, all goods are tradable, no idiosyncratic productivity Debate on reforms: More entry or reallocation across sectors? Suggestion: 1 Introduce idiosyncratic productivity shocks and export costs Endogenous tradability (Ghironi and Melitz, 25) 2 Implement structural reforms: What happens? More entry Non-tradable sector more competitive What happens to exporting firms? What else? Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 9 / 17

Product Market Deregulation in Ghironi and Melitz (25) FIGURE V Response to Permanent f E Shock (International Bond Trading) Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 1 / 17

2. Model: Labor Market Deregulation Two dimensions: 1 Cut workers bargaining power (increase η) 2 Cut unemployment benefits (reduce b) Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 11 / 17

2. Model: Labor Market Deregulation Two dimensions: 1 Cut workers bargaining power (increase η) 2 Cut unemployment benefits (reduce b) Cutting unemployment benefits Deregulate labor markets? Model: Probably yes, labor market becomes more efficient Reality: Wouldn t be my policy recommendation, especially in a crisis Reform labor markets in countries with 2% unemployment rates Employment is a state variable Flexecurity: Deregulation on firing side in exchange for more generous unemployment benefits (e.g. Boeri and Garibaldi, 28, for Italy) Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 11 / 17

2. Model: Nominal Rigidities Ascari and Rossi (212): Rotemberg Calvo only if Log-linear approximation No trend inflation Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 12 / 17

2. Model: Nominal Rigidities Ascari and Rossi (212): Rotemberg Calvo only if Log-linear approximation No trend inflation Non-linear equilibrium: Rotemberg (1982) Calvo (1983) Production function Y t = Z t L t Y t = Zt Lt c t Resource constraint Wedge Y t = Ct +Gt 1 r t Y t = C t + G t r = αr 2 (Π t 1) 2 c t = α c c t 1 Πθ t + (1 α c ) ( ) 1 α c Πt θ 1 θ θ 1 1 α c Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 12 / 17

2. Model: Nominal Rigidities Ascari and Rossi (212): Rotemberg Calvo only if Log-linear approximation No trend inflation Non-linear (partial) equilibrium: Shock that increases inflation Calvo: Increases c Negative productivity shock Rotemberg: Increases r Positive government spending shock Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 12 / 17

2. Model: Nominal Rigidities Calibrate α r such that same slope of linearized Phillips curve as in Calvo θ 1 α r = (1 α c)(1 α c β) α c α r = 116.5 Response to a 1 percentage point increase in product markup Output Consumption % deviations from s.s..1.2.3.4.5.6.7 1 2 3 4.2.4.6.8 1 2 3 4.14 Inlfation 4.5 Nominal Interest Rate annualized p.p..12.1.8.6.4.2 4.4 4.3 4.2 4.1 1 2 3 4 Calvo 4 1 2 3 4 Rotemberg Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 12 / 17

2. Model: Nominal Rigidities Calibrate α r as in CFG (from Bilbiie, Ghironi and Melitz, 28) α r = 8 Response to a 1 percentage point increase in product markup Output Consumption % deviations from s.s..1.2.3.4.5.6.7 1 2 3 4.2.4.6.8 1 2 3 4.14 Inlfation 4.5 Nominal Interest Rate annualized p.p..12.1.8.6.4.2 4.4 4.3 4.2 4.1 1 2 3 4 Calvo 4 1 2 3 4 Rotemberg Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 12 / 17

3. Current Account Effects Structural reforms as tool to correct external imbalances 1 Current Account 5 % of GDP 5 1 15 2 2 22 24 26 28 21 212 Germany Greece Ireland Italy Portugal Spain Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 13 / 17

3. Current Account Effects Structural reforms as tool to correct external imbalances Transfer resources into tradable sector or generalized internal devaluation Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 13 / 17

3. Current Account Effects Structural reforms as tool to correct external imbalances Transfer resources into tradable sector or generalized internal devaluation Historical Decomposition: German Net Exports, as % of GDP Historical Decomposition of German Trade Balance % of GDP (Kollmann et al., 213) Data Labor mkt reform Interest rate convergence External Demand Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 13 / 17

tput (top-left), inflation (top-right), sectoral output (middledle-right), interest rates (bottom-left) and international vari- Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 13 / 17 tput Sectoral Inflation 3. Current Account 1 Effects Structural reforms as tool to correct external imbalances % annualized Result sensitive to exact formulation of reforms 1 Eggertsson, Ferrero and Raffo (213): 1 p.p. reduction in goods and labor markups 15 2 5 1 15 2 e NT Home T Foreign NT Foreign tes International Variables 1 15 2 Real % deviation from s.s..5.5 5 1 15 2 RER TOT CA

3. Current Account Effects 1 3 1 1 3 3 1 1 3 3 µ µ* µ µ* 4 1 1.5 2 Structural reforms as tool to correct external imbalances 2 2 6 1 Result sensitive to exact formulation 3 of reforms 4 4 8 4.5 6 Cacciatore, Fiori and 5 Ghironi (213): 6 Product Market 1 Deregulation 3 Labor 1 Market 1 3 Deregulation 3 1 1 3 3 π d.5 1 1.5 2 2.5 CA 1 3 8 6 4 2 2 4.5 1 Σ PC CA 1 1 3 3 6 4 2 2 4 1 8 6 4 2 Σ PC* Σ PC 1 1 3 3 Figure 2: Home Product Market Figure Deregulation, 3: HomeHistorical Labor Market Policy Deregulation (Solid Lin are in percentage deviations from arethe in percentage Taylor rigideviations steady state. fromu the, UTaylo, π Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 13 / 17

3. Current Account Effects Structural reforms as tool to correct external imbalances Problem solved? Probably not because of structural reforms... 1 Current Account 5 % of GDP 5 1 15 2 2 22 24 26 28 21 212 Germany Greece Ireland Italy Portugal Spain Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 13 / 17

4. Monetary Policy: A Comparison with EFR EFR s main point: Reforms can be contractionary in a crisis Reforms are deflationary Real rate increases No monetary accommodation because nominal rate at ZLB Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 14 / 17

4. Monetary Policy: A Comparison with EFR EFR s main point: Reforms can be contractionary in a crisis Reforms are deflationary Real rate increases No monetary accommodation because nominal rate at ZLB CFG s result: Reforms are inflationary More entry, higher labor demand Real wage (marginal cost) increases Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 14 / 17

4. Monetary Policy: Questions 1 What happens to output and interest rates? Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 15 / 17

6 4 6 4 4. 2 Monetary Policy: 2 Questions 2 1 13 3 1 1 3 3 6 4 1 What happens to output and interest rates? 6 4 2.5 1 1.5 2 2.5 1 1 3 3.5 1 1.5 2 2.5 1.5.5 1 1 3 3 1: vityhome Shock, Productivity High Regulation, Shock, Historical High Regulation, Policy (Solid Historical Lines) versus Policy Optimal (Solid Lines) Policy versus (Dashed Optima Lines 2 Foreign likes Home reforms under optimal policy but not under Taylor rule les ge deviations are in percentage from thedeviations steady state. fromu the, U steady, π d and state. π d U, U, π d and π d are in deviations fromare theinsteady deviation stat How to represent optimal policy? ECB needs to know! Again, ZLB important in current context 2 1 C C* 2 1 1 2 3 C* U 1.5 2 1 3 1.5 U U* 4.5 2 1 1.5 2 U* N E 13 3 1 1 3 3 1 1 3 3 1 1 3 3 µ µ* µ* π d π d π d* π d* N E* Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 15 / 17

4. Monetary Policy Be careful with Taylor: Gerdesmeier and Roffia (23) from 1999 to 213 i t =.87 i t 1 +.13 [1.8 + 1.93 (π HICP t 1.5) +.28 (y t y trend 2 t )] 5 Nominal Interest Rate 4.5 4 3.5 Percent Annualized 3 2.5 2 1.5 1.5 Actual Predicted 2 22 24 26 28 21 212 Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 16 / 17

4. Monetary Policy Be careful with Taylor: Rudebusch (21) fits better recently (Nechio, 211) i t = 3.25 + 1.5 (π core t 1.5) + 1 (u t 8.2) 5 Nominal Interest Rate 4 3 Percent Annualized 2 1 1 Actual Predicted 2 22 24 26 28 21 212 Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 16 / 17

Conclusions Very nice paper Two main suggestions: 1 Introduce heterogeneous productivity (endogenous tradability) 2 Crisis experiment Andrea Ferrero (Oxford) Discussion of Cacciatore, Fiori and Ghironi November 29, 213 17 / 17