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



Φ1K 3,t / 3 )


- 1 + φ2 (1- WF )(1 - η)


*26, ï


(12)


may be preferable on empirical grounds. However, our experiment conducted so far reveal
that the model solution becomes less stable. This prevented us from implementing equation
(12) so far.

3ULYDWH (PSOR\PHQW

Labour is also a quasi fixed factor of production since it takes time for firms to reduce
employment or fill existing vacancies. Therefore a distinction between short and long run
labour demand elasticities must be made. Labour demand per employee is a positive
function of output and is negatively related to total real wage costs. These include - on top
of the gross wage rate per employee - a premium which depends on search and vacancy
costs of the firm
9&W.

In addition it is negatively affected by the markup the firm charges in product markets.

ι, = (1 - η)


α<,


(l-n∕)


(:r/3r +(и + 5 )9&r )


(13)


where V is the separation rate and YF are vacancy costs. It is assumed that vacancy costs are
proportional to the trend of real wages. Our Cobb Douglas assumption for technology
implies that the elasticity of employment with respect to output and real wage costs is equal
to one in the long run. The coefficients defining the markup
η is taken from a recent
OECD study which arrives at markup estimate for OECD countries lying in a narrow,
interval between 1.15 (for the US) and 1.26 (for Japan). Unfortunately there is no
information on vacancy costs for firms. We make the assumption that vacancy costs amount
to 10% of wage costs. We also allow for lagged adjusted of employment to changes in
demand and real wage costs. Our choice of functional form implies a wage elasticity of
labour demand equal to one. Estimated elasticities are usually somewhat smaller than one.
We have decided to retain the Cobb Douglas specification, in order to keep the model
simple. To replicate a smaller labour demand elasticity within this framework the speed of
adjustment parameter was set to a value which exceeds the estimated parameter, namely to
0.85 for EU countries, to 0.75 for the US and 0.925 for Japan.

(QHUJ\ 'HPDQG

Energy demand is similar to labour demand. It depends positively on the level of production
and is negatively related to relative energy prices which include energy taxes as an
important element.



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