Labor market institutions, productivity, and the business cycle: An application to Italy

This paper studies the effect of labor market institutions on the cyclicality of labor productivity and aggregate fluctuations in Italy when two wage bargaining protocols (efficient Nash and right-to-manage) interact with three types of hiring costs. It uses a New Keynesian model with labor market frictions and labor effort estimated with Bayesian techniques using Italian quarterly data from 1996Q1 to 2018Q4. We find that technology shocks mainly explain labor productivity fluctuations. We focus on labor market deregulation by reducing real wage rigidity, hiring costs, and workers’ bargaining power. We show that, when labor effort varies, reforms trigger procyclical productivity under efficient bargaining, and countercyclical productivity under right-to-manage bargaining. Reforms have different effects on the volatility of labor market variables. We carry out several sensitivity analyses which confirm our results. • This paper examines how labor market reforms affect the cyclicality of labor productivity and aggregate fluctuations when two wage bargaining protocols interact with three types of hiring costs. • The paper applies a New Keynesian model with labor market frictions and variable labor effort estimated with Bayesian techniques using Italian data from 1996Q1 to 2018Q4. • Counterfactual analysis shows that when labor effort varies, labor reforms trigger procyclical productivity under efficient bargaining, and countercyclical productivity under right-to-manage bargaining. • Reforms have different effects on the volatility of labor market variables.