Accounting for Labor Gaps

In this paper we develop a balanced growth model with labor supply and search and matching frictions in the labor market, to study the impact of economic policy variables on the two margins which constitute the (total) labor input: the extensive margin (the rate of employment) and the intensive margin (the hours worked per worker). We show that the dynamics of taxes primarily have an impact on hours worked, while labor market institutions have a significant influence on the rate of employment. However, our findings emphasize that there is an interaction between the two margins. The model is tested on four countries (US, France, Germany and the UK), which have experienced different tax and labor market dynamics since the sixties. Using this structural approach, we can then perform counterfactual experiments about the evolution of the policy variables, and compare the implications of policy changes in terms of production as well as average welfare.