QUEST II. A Multi-Country Business Cycle and Growth Model



Table 4: Parameters of wage equation

Bargaining
strength of
workers *
β

Contemporaneous
effect of U on
wages
ββt

Long Run Elasticity of Real Wages

Productivity

Unemployment **

BL

0.50

-0.90

10

1.18

DK

0.50

-0.90

1.0

1.11

DE

0.50

-0.65

1.0

0.89

GR

0.50

-0.55

1.0

1.24

ES

0.50

-0.88

1.0

1.86

FR

0.50

-0.90

1.0

1.27

IR

0.50

-0.48

1.0

0.71

IT

0.50

-0.95

1.0

1.44

NL

0.50

-0.95

1.0

1.42

OS

0.50

-1.60

1.0

2.53

PO

0.50

-0.64

1.0

1.45

UK

0.50

-0.50

1.0

0.74

SF

0.50

-0.75

1.0

1.28

SW

0.50

-1.10

1.0

1.83

US

0.25

-0.50

1.0

0.55

JA____________

0.50

-2.50_________

1.0__________

________3.47_________

Note:      * Imposed coefficients (see text)

** Estimation period 1973-1995.

%R[ 1HRFODVVLFDO /DERXU 6XSSO\

Labour supply or wage setting behaviour in the QUEST model differs strongly from the standard neo-
classical model of labour supply. However, in our new formulation of the wage equations we have
borrowed some elements of the neo-classical labour supply hypothesis. Therefore in order to motivate
some aspects of the wage equation the basic elements of the neo-classical labour supply hypothesis
are briefly introduced here.

In standard neo-classical labour supply models, the supply of labour is derived from a household
utility function where households value leisure positively. This implies that labour supply in terms of
hours (
K) depends positively on the net real wage rate (substitution effect) and negatively on
household wealth, which is composed of life cycle income and financial wealth (income effect)
alternatively on consumption which is proportional to
/&,W and ):W. This standard neoclassical labour
supply hypothesis can thus also be rephrased in terms of a wage equation:

: / 3Ct (1 - WO) = γ(/Clt + ):r ) / (1 - K) = γ,Ct / (1 - K)                        (28)

The interpretation of this equation is as follows: the left hand side of this equation gives the net real
consumption wage which induces an individual household to supply h hours of work per period for a
given permanent income. The net real wage rate is thus identical to the value of leisure as given by the
right hand side of equation (28) and defined as the ratio between the marginal utility of leisure and the
marginal utility of consumption (1/Ct). Besides unemployment benefits, the value of leisure
constitutes a part of the reservation wage. Under positive bargaining strength of workers, the wage
rate will exceed the reservation wage as defined by equation (28).

17



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