Central and Eastern European economies in a Goldilocks age: A model of labor market institutional choice

Abstract

We construct a simple model of a small, open economy with two macroeconomic variables of interest, namely, wage and employment dynamics and two institutions, namely, employment protection legislation (EPL) and minimum wage level (MW). Using stylized facts about macroeconomic performance and labor market reforms in Central Eastern European countries (CEEC) and assuming that the government wants to maximize equilibrium payroll, we can reproduce interesting labor market dynamics in these economies similar to those observed after the global financial crisis (GFC). This includes increased labor market resilience coupled with an increase in MW level and an implicitly higher EPL, with a partial reversal of a secular trend toward temporary employment. We conclude that a degree of complementarity (or at least weakened substitution) exists between worker-friendly EPL and MW policies in the peculiar economic circumstances that CEEC found themselves in the years after the GFC. We call these circumstances a Goldilocks period for the labor market.