Estimating the Employment Band of Inaction with Multiple Breaks due to Labor Market Reforms

Abstract

This paper proposes a new way of testing the effect of labor market reforms in the employment adjustment at the macro level. Following the approach to hysteresis based on the presence of non-convex costs of adjustment, a switching aggregate employment equation is estimated, with an unknown splitting factor, from a computational implementation of the linear play hysteresis operator. The play hysteresis operator describes a dynamics where non-convex adjustment costs create intervals of weak reaction of employment to small variations in forcing variables, while spurts in employment adjustment may occur as a consequence of a large, or cumulative small shocks. The main contribution of this paper is to extend an existing approach for the case where there are disruptive breaks, by accommodating changes in the value of the switching parameter of the employment equation whenever labor market reforms are present. Numerical experiments on the Portuguese economy are performed.