An Open Economy DSGE Model With Search-And-matching Frictions

An open economy DSGE model with search-and-matching frictions:
the case of Hungary
Zoltán Jakab∗and István Kónya†
November, 2009
Abstract
This paper builds a small open economy DSGE model augmented with search-and-matching frictions
on the labor market. The model is then estimated on Hungarian data between 1995-2008. Comparing our
findings to a model without matching frictions (Jakab-Vilagi 2008), we find that the added labor market
rigidity mutes the shock reactions of the economy significantly. In addition, we also find that many shocks
affect the labor market, but labor market shocks do not significantly spill over to other variables. As the
labor market is subject to real rigidities, the estimated nominal price and wage stickiness is lower than in
models without search-and-matching frictions.
1 Introduction
This paper examines the impact of introducing search frictions and sluggish wages in an open economy DSGE
model of Hungary. The model builds on the existing Hungarian DSGE model of Jakab and Világi (2008)1 , but
adds a more detailed labor market based on the Mortensen-Pissarides (1994) search-and-matching framework.
Our goal with this exercise is threefold.
First, we are interested in how the search-and-matching rigidities modify the workings of the model relative
to the baseline where sluggish wages are a result of Calvo wage setting by monopolistic wage setters (Erceg,
Henderson and Levin 2000). Since search-and-matching adds real rigidities to the determination of marginal
cost, it is expected that the model can deliver a smaller estimated price Calvo parameter and price indexation
which is more in line with the micro evidence. We report many results in comparison to JV2008, the benchmark
model in our exercise.
∗ FiscalCouncil, Republic of Hungary
† Magyar Nemzeti Bank and Central European University
1 We refer to this as the benchmark, or JV2008 model of the Hungarian economy.
1
Second, we are interested in how monetary policy and the labor market interact in a more realistic setting.
This way we hope to learn about the transmission of monetary policy shocks through the labor market, and
also the impact of labor market originated shocks to the rest of the economy.
Finally, we contribute to the existing literature on labor DSGE models by adding search and matching
rigidities to a small open economy framework. We do this primarily because the Hungarian economy is highly
open, so it is essential to include the export and import sectors (as well as foreign borrowing and lending)
to provide a realistic picture. On the other hand, we are able to explore interactions between labor market
rigidities and openness: the impact of shocks that originate abroad on the labor market, and the impact of
labor market disturbances on the exchange rate and the current account.
The model we develop is built from standard elements, adopted to some of the special features of the
Hungarian economy. Apart from the description of the labor market, we use a somewhat simplified version of
JV2008. The model has two final good sectors, producing domestically sold and exported differentiated goods
from a homogenous good. The homogenous good is produced using labor, capital, and imported intermediates.
This is the sector where search and matching frictions are found. Price rigidities, on the other hand, only
apply for the final good producers. Thus we follow much of the literature and separate the wage bargaining
and price setting decisions for analytical convenience (see Trigari 2006, for example). Imports are only used as
intermediate goods, which confirms to recent models that emphasize the importance of local distribution costs
(Burstein, Neves and Rebelo 2003).
Our exercise is similar to Christoffel, Kuester and Linzert (2006), who estimate a search-and-matching
augmented DSGE model on German data. Apart from the fact that they work with a closed economy, there
are some other important distinctions. First, we add other factors of production in addition to labor. We have
already explained the importance of imported intermediates (see also below the calibration exercise). Hungary
(on average) is growing faster than the advanced EU economies, and much of this growth is through capital
accumulation. Investment in Hungary plays an important role not only in growth, but also at business cycle
frequency and for monetary policy.
Second, we distinguish wage rigidity for existing jobs and new hires. Pissarides (2009) shows that the wage
rigidity of new hires is the important variable for job creation, while wages in existing jobs are not allocative
in this class of models. We incorporate this using different Calvo probabilities for being able to set the wage
in existing and new jobs (see Bodart, Pierrard and Sneessens 2006 and Konya and Krause 2009), and estimate
these separately.
Our model incorporates some additional features of the Hungarian economy, following JV2008. We allow for
the (short-run) non-rationality of inflation expectations in the form of adaptive learning. As inflation targeting
(IT) is relatively recent in Hungary, and inflation has been declining from relatively high levels (30% in 1995
and 10% in 2000, before the introduction of IT). Also, big inflationary shocks have hit the Hungarian economy
2
in the past few years. Thus we find it plausible to assume that agents’ expectations on trend inflation and the
inflation target are generated through an adaptive learning mechanism, and the estimates of JV2008 support
this view.
We estimated the model by Bayesian techniques on Hungarian data, taking into account the monetary regime
change in 2001. The estimated coefficients are similar to those found in JV2008, although - as expected - the
real rigidities on the labor market decrease the estimated price Calvo coefficients. Interestingly, we find price
indexation to be higher than in the benchmark model. Nominal wage rigidities are estimated to be relatively
low, which reinforces the results of JV2008. Bargaining power of workers is estimated to be relatively low, which
accords well with our prior given that Hungarian labor unions are weak.
By comparing impulse responses from the DSGE model of JV2008 and this model, we find relatively similar
price and nominal wage responses, but output and real wage responses are much more muted. This feature
of the model is more in line with other, non-DSGE evidence on the Hungarian economy than the benchmark
model.2
Unconditional variance decomposition of the estimated model reveals that foreign demand shocks, monetary,
risk premium, preference, government spending and productivity shocks are very important for most variables.
Labor market related shocks help in explaining wages and employment, but their impact on other variables is
limited. Thus the labor market seems to be absorbing shocks originating outside it, and it is also important for
the monetary transmission mechanism, but it does not seem to be a major source of shocks to the rest of the
economy (at least in our estimation period). The model also creates a more intensive link between real wages
and non-labor market shocks than JV2008 with its pure monopolistically competitive labor market. This makes
it more successful in explaining nominal wage inflation.
The rest of the paper is organized as follows. We first describe the model, with a special emphasis on the
labor market. Next we discuss our choice of parameter values and our calibration strategy. Then we present
impulse response functions to various shocks, and discuss the implications of introducing labor market rigidities
to a small open economy DSGE model. Finally, we describe the directions we plan to follow with this research
and then conclude.
2 The model
2.1 Households
The representative household maximizes intertemporal utility by selecting streams of consumption, investment
and foreign bond holdings. Consumption is subject to external habits, and investment is subject to adjustment
costs defined on the ratio of current and previous investment. Household members are either employed or
2 For a summary, see Vonnak (2007).
3
unemployed, but are able to fully insure each other against the random fluctuation of employment. This implies
that the representative household member’s utility function includes the average disutility of labor, χt nt . We
defer detailed discussion of the labor market to a later section.
Households’ problem can be written as

∞
1−ϑ
t εct (ct − hc̃t−1 )
max E0 βe − χt nt
t=0
1−ϑ
bt bt−1
s.t. ct + it + = + (1 − ut ) wt + ut bu + rtk Kt−1 + dt
pt Rt pt
I
eεt it
Kt = (1 − δ) Kt−1 + 1 − Φ it ,
it−1
where ct is consumption, c̃t−1 is average consumption in the previous period, nt and ut are the employment and
unemployment rates, it is investment, bt is bonds held by the household expressed in local currency, pt is the
consumer price index, wt is the real wage rate, rtk is the (real) rental rate on capital, kt−1 is the capital stock
carried over from the previous period, and dt is lump sum net income from other sources such as dividends
and government transfers. We assume that the investment adjustment cost Φ(·) is increasing and convex, with
Φ(1) = Φ′ (1) = 0 and Φ′′ (1) > 0.
We use the usual assumption in the labor DSGE literature (see Merz, 1995 and Andolfatto, 1996) and assume
that households provide perfect consumption insurance for their members. Thus the marginal utility of income
is the same for workers and the unemployed, and we can use the representative consumer assumption in what
follows. Note that this assumption is already reflected in the utility function and the budget constraint. The
representative consumer suffers the disutility from work χt with probability nt , where χt is stochastic with an
expected value of χ̄. The unemployed draw unemployment benefits bu , which are financed by lump-sum taxes
included in the term dt .
Using λ and λQ as the Lagrange multipliers for the two constraints, the first-order conditions (except for
4
labor) are given as
c −ϑ
eεt (ct − hc̄t−1 ) = λt (1)
λt λt+1
= βRt Et (2)
pt pt+1
I I
I
eεt it
eεt it ′ eεt it
1 = Qt 1 − Φ − Φ
it−1it−1 it−1
2 εI
λt+1 εIt+1 it+1 ′ e t+1 it+1
+βEt Qt+1 e Φ (3)
λt it it
k
λt+1
Qt = βEt (1 − δ) Qt+1 + rt+1 (4)
λ
I t
eεt it
Kt = (1 − δ) Kt−1 + 1 − Φ it . (5)
it−1
The first equation defines the marginal utility of income λt , the second is the household Euler equation, the
third describes investment behavior, and the last is an arbitrage condition between investment into bonds and
capital.
2.2 The wholesale sector
The wholesale sector produces a homogenous product, using capital, imported intermediates and labor. Capital
and intermediates are acquired at competitive factor markets at factor prices rtk and pm m
t . Note that pt indicates
the (exogenous) foreign currency price of the intermediate input. The labor market is subject to search-and-
matching frictions. Each job is a firm-worker pair, subject to an exogenous, stochastic job destruction probability
ρt .
The aggregate production function is given by the following Cobb-Douglas specification:

αz 1−αz 1−α
Yt = eat Ktα Ym,t Nt ,
where Yt is the amount of output produced, at is an exogenous shock, Kt is capital, Ym,t is imported interme-
diates and Nt is the number of workers employed.
We assume that each firm employs one worker, thus we rewrite the production functions in a per-worker
form:
α (1−α)
yt = eat ktα ym,t
z
Given the Cobb-Douglas specification and the fact that the capital and import markets are competitive, demand
5
for these inputs is given by the familiar conditions:
rtk kt = αpw,t yt
pm,t et
ym,t = (1 − α) αz pw,t yt ,
pt
where pw,t is the relative price of wholesale goods. The equations imply that the flow benefit of a job match for
a firm is given by
ξ t = (1 − α) (1 − αz ) pw,t yt . (6)
2.2.1 Job flows
As is typical in the literature, new jobs are created when unemployed workers meet open job vacancies. The
number of matches is described by a constant returns to scale, Cobb-Douglas matching function:
mf
mt = σm eεt vtσ ut1−σ ,
where mt is the number of new matches, vt is the number of open vacancies, and ut is the number of unemployed
and εmf
t is a shock to the matching technology.
We follow the timing convention of Gertler, Sala and Trigari (2008). Employment nt evolves according to
the flow equation
nt = (1 − ρt ) nt−1 + mt ,
where ρt is the exogenous separation rate. Notice that we assume a match becomes productive immediately.
Finally, unemployment is given by
ut = Lt − nt−1 ,
where Lt is the exogenously given size of the labor force. Thus workers who loose their jobs have to wait one
period to be able to search for a new one, but those who enter the workforce can search immediately.
For future reference, we use the following (standard) notation: qt = mt /vt is the job filling rate, st = mt /ut
is the job finding rate, and θ t = vt /ut is job market tightness.
2.2.2 Firms
We base our description of the wage setting process on Bodart, Pierrard and Sneessens (2006) and Konya and
Krause (2009). In particular, we distinguish between wage of new hires, and wages in existing jobs. Both wage
setting processes are described by a Calvo probability. In particular, nominal wages wt in existing jobs are
bargained with a probability of 1 − γ w , otherwise the wage is left at last period’s wage. For new hires, the
6
nominal wage is negotiated with probability 1 − ϑw , otherwise it is set at last period’s average wage Wt−1 .
We use the notation of Wt∗ to indicate wages that are set optimally in period t. Since the derivation of the
equilibrium conditions is lengthy, we relegate details to Appendix C and present only the main equations here.3
Let Vt denote the value of a vacancy and let Jt denote the value of a filled job. Creating a vacancy costs κ
units, measured in utility terms.4 Since a vacancy is filled with probability qt and the wage bargain takes place
with probability ϑ, Vt is given by
κ
Vt = − + qt [ϑw Jt (Wt−1 ) + (1 − ϑw ) Jt (Wt∗ )] (7)
λt
We assume the usual free entry condition to post a vacancy, which implies that the value of vacancies is
identically zero, Vt ≡ 0.
Let Jt (wt∗ ) denote the value of a job that was renegotiated at t, and it is given by
wt∗ λt+1

∗
Jt (Wt∗ ) = ξ t − + βEt 1 − ρt+1 γ w Jt+1 (wt∗ ) + (1 − γ w ) Jt+1 wt+1 . (8)
pt λt
where we used free entry condition for vacancies. In the Appendix we show that using the vacancy equation
and the appropriate value functions when wages are not adjusted, we can rewrite (8) as

wt∗ λt+1 κ 1 − ρt+1
Jt (Wt∗ ) = ξt − + βEt
pt λt λt+1 qt+1
∗ ∗
∗ ∞ j
wt+1 wt ϑw wt+1 wt λt+j j

+ Et − − − (βγ w ) 1 − ρt+s (9)
pt+1 pt+1 γ w pt+1 pt+1 j=1
λt s=1
2.2.3 Workers
Unemployed workers receive an income b while unemployed, which includes unemployment and other welfare
benefits and the value of leisure. Thus the value function Ut can be written as
χt λt+1
∗
Ut = bu + + βEt st ϑw Wt+1 (wt ) + (1 − ϑw ) Wt+1 wt+1 + (1 − st ) Ut+1 (10)
λt λt
The value of a job when the wage is just negotiated is given by
wt∗ λt+1

∗
Wt (wt∗ ) = + βEt 1 − ρt+1 γ w Wt+1 (wt∗ ) + (1 − γ w ) Wt+1 wt+1 + ρt+1 Ut+1 . (11)
pt λt
3 An alternative to nominal wage rigidity would be to assume that real wages are sticky. The final equations would be almost
the same, except that the wage Phillips curve below would refer to the real wage. Since in Hungary nominal wage rigidity seems
to be more relevant, we use this assumption here.
4 The only reason for this assumption is that it makes the vacancy cost dependent on λ , and hence procyclical.
t
7
Similarly to firms, we can manipulate the value functions to express the net value of a job to workers as
wt∗ χ
λt+1
∗
Wt (wt∗ ) − Ut = − bu − t + βEt 1 − ρt+1 − st+1 Wt+1 wt+1 − Ut+1 (12)
pt λt λt
∗
∗ ∗
wt+1 wt st+1 ϑw wt+1 wt
− Et − − Et
− ·
pt+1 pt+1 1 − ρt+1 γ w pt+1 pt+1
∞
j

λt+j j

(βγ w ) 1 − ρt+s (13)
j=1
λt s=1
2.2.4 Wage bargaining
When wages are negotiated, we assume that they are set as a solution to the generalized Nash bargaining
problem, as it is standard in the literature. Thus the wage wt∗ solves
max
∗
[Wt (wt∗ ) − Ut ]η Jt (wt∗ )1−η ,
wt
where the parameter η measures the bargaining power of workers. Using (9) and (12), it is easy to see that the
solution to this problem is given by
(1 − η) [Wt (wt∗ ) − Ut ] = ηJt (wt∗ ) . (14)
Using again equations (9) and (12), we can rewrite the wage setting condition as follows:

wt∗ βκ χt
= η ξt + Et θ t+1 + (1 − η) bu +
pt λt λt
∞ j
∗
λt+j j

∗
wt+1 wt∗ st+1 ϑw wt+1 wt
+Et (βγ w ) 1 − ρt+s − −
− (15)
j=1
λt s=1
pt+1 pt+1 1 − ρt+1 γ w pt+1 pt+1
Thus the wage that is set at time t is a combination of what it would be without any rigidity for existing jobs
(the first two terms), and a term that captures the possibility that the newly set wage remains effective for
some time period.
2.2.5 Average wages
Recall that wt∗ is the wage rate that is bargained at period t. The evolution of the average wage depends both
on the newly set wage and on those wages that are not allowed to reset. Let wt denote the economy wide
average wage, which evolves according to
mt (1 − ρt ) nt−1
wt = [ϑw wt−1 + (1 − ϑw ) wt∗ ] + [γ w wt−1 + (1 − γ w ) wt∗ ] (16)
nt nt
8
Let us define the "flexible real wage" as

βκ χ
ωt = η ξt + Et θ t+1 + (1 − η) b + t , (17)
λt λt
which would be the wage under continuous Nash bargaining. Log-linearizing (15) and (16), and noting that in
the steady state m̄ = ρn̄, we can derive the following wage Phillips curve:
β [(1 − ρ̄) γ w − s̄ϑw ] [1 − ρ̄ϑw − (1 − ρ̄) γ w ] [1 − βγ w (1 − ρ̄)]

π̂w
t = Et π̂w
t+1 + (ω̂ t − ŵt + p̂t ) (18)
ρ̄ϑw + (1 − ρ̄) γ w ρϑw + (1 − ρ̄) γ w
As the equation shows, wages are persistent, but wage inflation is not. Wage persistence, intuitively, depends
on three parameters: the exogenous Calvo probabilities γ w and ϑw , and the job destruction rate ρ. The latter
enters because job destruction equals job creation in steady state; without log-linearization wage evolution
would also change with the hiring activity in the economy.
2.2.6 Job creation
We can use (7), (9) and (14) to derive the job creation condition as

κ wt∗ κ 1 − ρt+1
= ξt − + βEt
λt qt pt λt qt+1
∗ ∗ ∞ j
wt+1 wt∗ ϑw wt+1 wt λt+j

+ Et − − − (βγ w )j 1 − ρt+s
pt+1 pt γ w pt+1 pt+1 j=1
λt s=1

∞ j
wt∗ wt−1 λt+j

+ϑw − (βγ w )j 1 − ρt+s (19)
pt pt j=0
λt s=1
Notice that if there is no wage rigidity for new hires, i.e. ϑw = 0, the job creation condition is identical to the
one under continuous Nash bargaining. This is the point made by Pissarides (2009): for job creation and hence
unemployment volatility, only the wages of new hires matter. With wage rigidity for new hires, however, job
creation responds not only to next periods shocks, but also to the evolution of the average wage.
2.3 Final goods
The final good sector contains an infinite number of monopolistically competing firms, who buy the homogenous
wholesale good and differentiate it. Consumers value the differentiated final goods according to the following
CES utility function:
1 1+µt
1
ytF = ytF (i) 1+µt di ,
0
9
where yj,t (i) is a typical variety in sector j, and µj,t is the time-varying markup parameter. Demand for variety
i is then
−1−1/µt
Pt (i)
ytF (i) = ytF .
Pt
Variety producers act as monopolists, and choose prices when allowed. We use the well-known Calvo
assumption, so that firms can reoptimize prices with probability 1 − γ. Those firms which do not optimize at
the given date follow a rule of thumb. Rule of thumb price setters increase their prices by the expected average
rate of inflation, as in Yun (1996), and to some extent by the difference between the past actual and perceived
underlying inflation rates, similarly to Christiano et al. (2001), the SIGMA model at the FED (see. Erceg et al
2006) and Smets and Wouters (2003). However, here the indexation term applies not just to actual aggregate
inflation, but to some extent to a perceived value (Π̄t+1 ), which agents constantly learn by a real-time adaptive
learning algorithm.
Formally5 ,
ϑ
1 + Πt

Pt+1 (i) = Pt (i) 1 + Π̄t+1
1 + Π̄t
ϑ ϑ
Pt St−1 St+1 P̂t St+1
= Pt (i) = Pt (i) ,
Pt−1 St St P̂t−1 St
where ϑ measures the degree of indexation according to past cyclical inflation measures (indexation to perceived
underlying inflation is complete), Sk+1 = (1 + Π̄k+1 )Sk , k ≥ t − 1, and St−1 = Pt−1 is given, furthermore
P̂t = Pt /St . This implies that
Ps (i) = Pt (i)S̄s,t , (20)
where ϑ
P̂s−1 Ss
S̄s,t = .
P̂t−1 St
If firm i sets its price optimally at date t it solves the following maximization problem.
∞
λs −1−1/µs
max = Et (βγ)s−t ysF (i)Ps1+1/µs Pt (i)S̄s Pt (i)S̄s − Ps pw,t ,
Pt (i)
s=t
λt
This implies the following first order condition:
∞

λs s 1 1
Et (βγ j )s−t s (i) 1+ Pt Pt (i)−1 pw,t − S̄s = 0, (21)
λt j,t µs µs
T =t
1+1/µs −1−1/µs
where sst (i) = ys Ps Pt (i)S̄s .
5 We drop the industry index j when no confusion arises.
10
As indicated above, agents apply a real-time adaptive algorithm to identify the underlying inflation rate,

π̂pt = ρπ π̂pt−1 + g π̂ t − π̂ pt−1
Here π̂t is the observed actual, π̂ pt is the perceived underlying inflation rate (both expressed in log deviation
from the steady state). The gain parameter g influences the speed of learning. The advantage of this setup is
that the price Phillips curve takes the same form as in a model without learning (see the Appendix), except
that the inflation variable is the difference between true and perceived inflation,
dπ̂ ≡ π̂t − π̂pt .
Note that learning only applies to the domestic sector, as uncertainty about monetary policy does not influence
the export price (which is expressed in foreign currency).
2.4 Equilibrium
Final goods are sold domestically and exported. The wholesale sector is composed of nt firms producing yt units
of the wholesale good each. Let nd,t denote the number of firms (and workers) who serve the domestic retail
sector, then domestic final sales are given by nd,t yt . These are used for consumption, investment, and government
consumption. The latter is assumed to be exogenous and unproductive, described by an autoregressive process.
The domestic equilibrium condition is then given as
nd,t yt = ct + it + gt .
Aggregate capital is the sum of firm-level capital,
Kt = nt kt .
Monetary policy is represented by a simple Taylor rule:
r̂t = ζ r r̂t−1 + (1 − ζ r ) (ζ π Et π̂t+1 + ξ e êt ) + εm

t . (22)
We assume that the monetary authority sets the interest rate, and reacts to expected inflation and the unem-
ployment rate. We allow for interest rate smoothing when ξ r > 0. For technical reasons the interest rate also
has to react to the exchange rate, but we set ξ e to be very small.
We assume that the country is a small open economy, which has two implications for external links. First,
11
a modified UIP condition holds, where the interest rate on home currency denominated foreign bonds is given
by the constant world interest rate plus an endogenous risk premium:

et Rt 1 U IP
= + ψ(e−(Bt −B̄) − 1) eεt . (23)
Et et+1 β
We follow Schmitt-Grohé and Uribe (2003) and make the risk-premium a function of the net foreign asset
position B. Second, we posit an ad-hoc export demand equation
x
(nt − nd,t ) yt = (pxt )−θx Y w eεt (24)
which is subject to habit formation. We include a foreign demand shock which has been shown to be important
in the case of Hungary.
Finally, we can rewrite the household budget constraint to get the current account:
bt bt−1
− = px,t nx,t yt − p∗m,t nt ym,t . (25)
et Rt et
We assume that the foreign currency price of imported intermediates is exogenously given. This implies that
their domestic currency price is given by:
et
pm,t = p∗m,t ,
pt
where et /pt is the real exchange rate.

Equations (5) through (22) together with the exogenous evolutions of the structural shocks describe the
equilibrium dynamics of the system. We log-linearize the equations around the non-stochastic steady state,
and solve the linearized system. The full list of our log-linearized equations is contained in the Appendix A.
3 Calibration
3.1 Non-labor market parameters
We begin by setting the steady state level of net foreign assets B̄ = 0, and the steady state level of the exchange
rate and the export price to ē = 1 and p̄x = 1. We use (2), (3) and (4) to get
1
R̄ =
β
1
r̄k = − 1 + δ.
β
12
Calibrated parameters
Discount factor β 0.99
Steady state share of capital in real marginal costs αk 0.15
Steady-state share of imported inputs in intermediates αz 0.55
Depreciation rate δ 0.025
Markup in final goods (domestic, export) µ, µx 0.2
Investments adjustment cost Φ′′ (1) 13.00
Exchange rate elasticity of the policy rule ζe 0.025
Debt elasticity of financial premium ψ 0.001
Autoregressive learning parameter ρπ 0.99
Learning gain g 0.234
Autoregressive coefficient of gov’t spending shock ρg 0.681
Autoregressive coefficient of gov’t spending shock ρpm 0.773
Autoregressive coefficient of gov’t spending shock ρde 0.586
Matching function elasticity σ 0.5
Average job finding rate s̄ 0.18
Average unemployment rate ū 0.07
Separation rate ρ 0.0135
Table 1: Calibrated parameter values outside the labor market
The discount rate is calibrated to match a steady state annualized real interest rate of 4%, and the depreciation
rate is set to δ = 0.025.
Given the Cobb-Douglas assumption for the final good sectors, we calibrate the share parameters from the
following equations:
(1 + µ̄) r̄k k̄
αd =
ȳd
(1 + µ̄) p̄m ȳ m
αz =
(1 − α) ȳ
As usual in the literature, the steady state mark-ups are set to µ = µx = 0.2.
For the other parameters that are not estimated, we use values from JV2008. These parameters are the
investment adjustment cost (Φ′′ (1) = 13) and the debt elasticity of the risk premium (ψ = 0.001). We also fixed
ζ e and ψ. These are technical parameters. Their only role is to assure stationarity of the model. The learning
gain parameter was also set fixed and took the value estimated by JV2008. In order to decrease the number of
parameters to be estimated, three autoregressive parameters of shocks (import price, government spending and
the shock to the learning rule of perceived underlying inflation) were estimated by OLS.
3.2 Labor market parameters
The value of the matching function elasticity is set to σ = 0.5, which is standard in the literature; Petrongolo
and Pissarides (2001) argue that this is in the reasonable range of estimates. Since we do not have evidence on
the bargaining power of workers, we estimate it using 0.5 as the prior mean. The (steady state) job finding s̄
13
rate is taken from Hobijn and Sahin (2007), who compute these rates for OECD countries. The quarterly value
for Hungary is s̄ = 0.18. Finally, we use the average unemployment rate in the sample to pin down the steady
state unemployment rate at ū = 0.07.
The value of non-labor activity is difficult to reliably calibrate. It is a combination of unemployment benefits,
home production, and the value of leisure. Since we lack reliable estimates of at least the last two, we decided
to estimate. Also note that we allow for a shock to the outside option given the large changes in policy in the
sample period.
The remaining parameters and moments can be calculated from steady state conditions. We use the definition
of the job finding rate and the equation n̄ = 1 − ū to get the separation rate, which is
s̄ū
ρ= .
1−u
For the chosen values for s̄ and ū, the implied value is ρ = 0.0135. This is much lower than in the US, but
comparable to European numbers and very similar to Hobijn and Sahin (2007). The steady state level of
vacancies is hard to measure, but luckily we only need to compute κθ to solve the model. This can be done
using the steady state wage equation and job creation condition, along with the wage rate. Appendix B contains
the relevant equations.
4 Bayesian Estimation
The estimation of the DSGE model used Hungarian quarterly data of twelve macroeconomic variables: real
consumption, real investments, real exports, real imports, real government consumption, real wages, employ-
ment, CPI inflation rate, nominal interest rate, import and export prices denominated in foreign currency, and
the exchange rate. All real variables are HP-filtered with the standard smoothing parameter (λ = 1600) for
quarterly data. Unlike in JV2008 data for the capital stock were not found informative throughout the estima-
tion. According to the variance decomposition capital stock was merely explained by its own shocks. Hence,
we dropped the capital stock from the observed variables. Estimation is based on an updated quarterly data
set presented in Benk et al. (2006) and JV2008. We also experimented with vacancy data, but due to its poor
quality we did not rely on it in the final estimation. The estimation sample covers the period of 1995:2-2008:3.
We applied a likelihood-based Bayesian method described in An and Schorfheide (2005). After setting up
a rational expectations solution of the model, we constructed the likelihood function using a Kalman-filter.
Then, this likelihood function is combined with prior distributions and this gives the posterior density function
of parameters. Finally, we ran a random-walk Metropolis-Hastings (MH) algorithm to generate the posterior
distribution.
14
One problematic aspect of our dataset is that there was a distinct monetary regime change in 2001:2. In the
first part of our sample an exchange rate targeting regime (a crawling-peg) was in place, while in the second
subsample monetary policy followed an inflation targeting framework. This structural break was explicitly taken
into account by JV2008 by estimating two non-nested models with differences in the parameters of the Phillips-
curve and the monetary reaction function. Unfortunately, the model was not identified by using the methodology
of JV2008: there were serious convergence problems. In order to take care of the regime change we opted for
an alternative estimation technique by using a two-step estimation strategy. At the first stage we estimated the
model on the first subsample (in which monetary reaction function was ’switched off’). Then, as a second-step
we estimated on the second subsample by applying the posterior means resulting from the first regime. The
shape and the standard deviation of prior density for the second regime was set equal to that in the first regime.
The advantage of this method is that it deals with the structural break. But there is one clear drawback. Some
loss in information might occur throughout the estimation as only a subsample is utilized when estimating
coefficients for the first regime. It is worth noting, that under this two-step methodology, finding similar values
for the prior and the posterior in the second regime does not necessarily show identification problems. It may
just indicate that the monetary regime change did not have a significant effect on the parameter of interest.
4.1 Specifying prior distributions
All the standard deviations of the shocks are assumed to be distributed as an inverted Gamma distribution
with mean and standard errors of five percent. Prior distributions of autoregressive parameters are assumed to
follow Beta distributions with mean of 0.5 and standard error of 0.15 for all shocks, except for monetary policy,
domestic and export markup shocks which were assumed to follow a white noise process. The reason is that
the model treats VAT and regulated price changes as markup shocks and these events were relatively frequent
in Hungary during the estimation sample. For the monetary policy shock we assume no long-lasting deviations
from the policy rule. As mentioned above, in order to restrict the number of parameters to be estimated, the
autoregressive coefficients of import price and government spending shocks were estimated separately by OLS.
The autoregressive parameter of the learning rule was calibrated.
Prior distributions for the rest of estimated parameters are shown in Table 2. Loose priors for the Calvo
and indexation parameters are assumed and they were set to be equal to a Beta distribution with mean 0.5 and
standard error of 0.15.
The choice of prior for the parameter of interest rate smoothing ζ i is different from the literature. We used
a relatively uninformative Beta prior distribution. The mean value for the consumption preference parameter
ϑ was set similar to that of JV2008. The prior for the parameter for consumption habits h was set close to the
posterior mean found by JV2008 with standard error of 0.15 and a Beta prior distribution.
Three parameters relating to search-and-matching frictions were also estimated. These parameters are
15
important not only in the cyclical behavior, but in the long run steady state of the model. The unemployment
replacement rate (bu ) and the steady state value of the disutility of labor (χ/λ̄) received relatively loose priors:
Beta distributions with priors means 0.6 and 0.2 and standard errors of 0.1.The sum of the two parameters is the
opportunity costs of work for workers. As the number of inactives in the total population is relatively high by
international standards, we applied a relatively high overall prior mean for the opportunity cost. However, since
large standard errors were chosen, this choice is hardly binding. Finally, we applied a relatively uninformative
Beta prior for the parameter measuring the bargaining power of workers (η), with mean 0.5 and standard error
of 0.1.
4.2 Estimation results
Table 2 summarizes our estimation results. The Calvo price parameters in the domestic sector in both regimes
were found very close to each other. They turned out to be close to the ones usually found in the literature, but
a bit lower then the one estimated by JV2008 for both regimes. Consumer prices are somewhat more flexible
in this model than in JV2008. In addition, we found less role for indexation, the parameters are estimated to
be well below the one estimated by JV2008. Like JV2008 we also found a significant shift in the indexation
mechanism after the monetary regime shift. In the exchange rate targeting regime indexation in consumer
prices are estimated to be higher than in the IT-regime. This confirms to our intuition: one would expect more
important indexation in a regime with higher inflation and credibly pre-announced nominal depreciation than
in a regime without such commitments by the authorities.
Export prices are estimated to be less rigid than domestic prices which is in line with the benchmark DSGE
model. Similarly to JV2008 indexation of export prices are less relevant than for domestic prices in the first
regime, while in the second regime they are scarcely different. We report an increase in the stickiness of the
export price (higher Calvo-parameters) in the second regime compared to the first one. The price elasticity
of export is estimated to be significantly lower than in the benchmark model. The parameters of inflation in
the monetary reaction function were estimated to be close to the benchmark model of JV2008. Like in the
benchmark model, the interest rate smoothing parameter is estimated to be lower than usually found in the
literature. On the other hand, we were not very successful in the estimation of the parameter of inflation in the
monetary reaction function: prior and posterior distributions are quite similar.
As far as nominal wage rigidities are concerned, our results point to a relatively low extent of rigidities. This
is in line with the benchmark model. Both Calvo parameters (for new and existing hires) are found to be lower
than that of consumer prices in both regimes. Plausibly, wages of new hires are found to be less rigid than that
of old ones in the first regime. On the other hand, somewhat in contrast to our prior beliefs, wage rigidities
are very close to each other in the second regime. A convergence of the two parameters are estimated after the
regime change. The frequency of wage changes of old and new hires became similar after 2001.
16
Prior distribution* Estimated posterior
Regime 1 Regime 2
Stand. 90% 90%
Type Mean err. Mean prob. int. Mean prob. int.
Utility function parameters
consumption ϑ Norm. 2.00 0.40 2.160 1.77 2.52 1.979 1.68 2.26
habit h Beta 0.60 0.15 0.705 0.62 0.78 0.682 0.57 0.76
Price and wage setting param.
ind. cons. prices ϑp Beta 0.50 0.15 0.759 0.63 0.90 0.163 0.10 0.23
ind. exp. prices ϑx Beta 0.50 0.15 0.294 0.18 0.41 0.174 0.07 0.27
Calvo cons. prices γ Beta 0.50 0.15 0.873 0.85 0.90 0.902 0.89 0.92
Calvo exp. prices γx Beta 0.50 0.15 0.367 0.27 0.47 0.487 0.42 0.55
Labor market parameters
Calvo wages, old γw Beta 0.50 0.15 0.617 0.53 0.71 0.508 0.40 0.63
Calvo wages, new ϑw Beta 0.50 0.15 0.417 0.27 0.59 0.511 0.41 0.63
Bargaining power η Beta 0.50 0.10 0.106 0.05 0.15 0.092 0.03 0.15
Steady state outside option b̄ Beta 0.60 0.10 0.573 0.50 0.69 0.541 0.44 0.62
Steady state disutility of labor χ Beta 0.20 0.10 0.179 0.08 0.27 0.175 0.04 0.29
Other parameters
exp. elasticity η Beta 0.50 0.15 0.387 0.21 0.56 0.288 0.10 0.41
ir. smooth.** ξr Beta 0.50 0.15 - - - 0.699 0.62 0.77
policy rule** ξπ Norm. 1.50 0.16 - - - 1.532 1.36 1.74
Autoregressive coefficients
Productivity ρa Beta 0.50 0.15 0.555 0.46 0.65 0.586 0.51 0.67
Matching ρmf Beta 0.50 0.15 0.337 0.23 0.45 0.488 0.35 0.63
Risk premium ρuip Beta 0.50 0.15 0.687 0.60 0.78 0.785 0.71 0.86
Export demand ρx Beta 0.50 0.15 0.677 0.54 0.81 0.741 0.67 0.81
Investments ρi Beta 0.50 0.15 0.594 0.46 0.75 0.266 0.20 0.33
Preference ρd Beta 0.50 0.15 0.418 0.24 0.58 0.405 0.27 0.56
Participation ρl Beta 0.50 0.15 0.665 0.54 0.82 0.645 0.58 0.72
Outside option ρb Beta 0.50 0.15 0.730 0.62 0.83 0.684 0.57 0.77
Separation ρρ Beta 0.50 0.15 0.606 0.40 0.82 0.598 0.51 0.69
*Unless otherwise noted, the posterior means estimated for the first regime are the prior means
in the second regime. The prior shapes and standard errors are equal in the two regimes.
**The parameter is only estimated for the second regime.
Table 2: Estimated parameters
Bargaining power of workers is estimated to be relatively low and constant throughout the two regimes.
This again seems to be plausible as unionization is rather low in Hungary. Estimation of the steady state value
of outside option was not satisfactory. It seems that data were not very informative as priors and posteriors
almost coincide. Interestingly, the outside option is (although insignificantly) lower for the second regime. This
is somewhat against our intuition as the Hungarian governments increased the minimum wage during the second
regime, which would suggest a higher value for bu . As far as the parameter of the steady state disutility of labor
χ/λ̄ is concerned, priors and posteriors are found to be close to each other.
5 Impulse response analysis
We calculated impulse response functions of the estimated model by allowing for one-period, 1 percentage point
shocks. Our model qualitatively reproduces other DSGE models and the one presented by JV2008. There
are, however, some significant differences. Consumption responses are driven by the Euler-condition and all
consumers are fully forward looking and do not face financial or liquidity constraints (rule-of-thumb consumers
are absent). Therefore, consumption is in most cases more sensitive to shocks than in the model of JV2008 (one
17
exception is the productivity shock).
The evolution of actual real wages and the Nash-wage are very different. By construction, the latter is the
more flexible one. The Calvo coefficients of both old and new wages are lower than the ’average’ wage stickiness
estimated by JV2008. Both types of nominal wages are relatively flexible and thus, average nominal wages
show a fairly strong response for most of the shocks compared for example to that of prices. The model thus
describes an economy with a rather limited role for intrinsic nominal wage rigidities.
In this model there is no possibility for adjustment on the intensive margin (through hours). This, together
with the presence of search-and-matching frictions and nominal wage stickiness makes employment reactions
limited. Sluggish employment response is then translated into relatively flexible and persistent and erratic
changes in capital and imports.
The different behavior of wages of new and old hires creates an additional channel for firms’ adjustment by
hiring , which together with the heterogeneity in wages of new and old hires makes nominal wages somewhat
more responsive than consumer prices.
The model replicates the drop in employment after a positive productivity shock, which is in line with the
finding of JV2008. Although nominal wages fall, this decrease is not sufficient compared to the short run fall
in Nash-wages. Bargained wages become relatively expensive and thus, vacancies decrease after a productivity
improvement. As employment (and consequently unemployment) only slightly changes and there is no room
for adjustment at the intensive margin, a substitution from labor to capital arises. As standard in models with
optimizing households (not as in the benchmark model of JV2008 where non-optimizers’ consumption drops in
the short run) consumption increases both in the short and in the longer run.
Under the monetary policy shock the responses are generally standard, though the reactions of employment
and output are weak. (see Figure 2 ). Figure 3 shows the effects of a domestic markup (cost push) shock. After
this shock, prices are higher but a bit surprisingly, GDP hardly changes. This can be again explained by the
heavy adjustment of imports. Employment, consumption drop and the labor market becomes looser.
Turning to the shocks associated with the labor market, the model shows interesting features and perhaps
helps in understanding labor market movements. An outside option shock (e.g. an increase in the minimum
wage) improves the relative bargaining position of employees, which pushes up wages for both current and new
workers. However, the wage of existing hires also goes up and firms substitute labor with capital. In general
equilibrium prices are somewhat higher and the labor market does not become tighter (see Figure 4 ).
The other labor market shock is related to an exogenous change in participation. A positive participation
shock means that some of the inactives suddenly start to search (e.g. due to government measures). However,
this does not translate into significantly looser labor market as many of the new entrants become unemployed.
This shock, however, works as a typical labor supply shock as real wages fall and thus finally, employment is
higher. Interestingly, there is a strong substitution effect and cheaper labor and higher employment crowds out
18
e(sol), reer(dash) real w(sol) Nash wage(dash) nom. wage infl(sol)
0.1 0.1 0.2
0 0 0
-0.1 -0.1 -0.2
-0.2 -0.2 -0.4
-0.3 -0.3 -0.6

0 5 10 15 20 0 5 10 15 20 0 5 10 15 20
pi(sol) cycl infl(dash) int(sol) gdp(sol) c(dash) i(dot)

0.1 0 0.6
0 -0.05 0.4
-0.1 -0.1 0.2
-0.2 -0.15 0
-0.3 -0.2 -0.2

0 5 10 15 20 0 5 10 15 20 0 5 10 15 20
x(sol) m(dash) n(sol) k(dash) tightness(sol) v(dash) u(dot)

1 0.06 0.5
0.04
0 0
0.02
-1 -0.5
0
-2 -0.02 -1
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20
Figure 1: Productivity shock

0.5 0.5 0.5
0 0
0
-0.5 -0.5
-0.5
-1 -1
-1.5 -1 -1.5
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20

0.1 1
0
0
0.5
-0.1 -0.2
0
-0.2
-0.4
-0.3 -0.5
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20

0.1 0.02 0.5
0 0
0
-0.1 -0.02
-0.5
-0.2 -0.04
-0.3 -0.06 -1
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20
Figure 2: Monetary shock
19
capital accumulation (see Figure 5 ).
-3
e(sol), reer(dash) x 10 real w(sol) Nash wage(dash) nom. wage infl(sol)
0.04 0 0.01
-2
0.02
-4 0.005
0
-6
-0.02 -8 0
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20
-3
pi(sol) cycl infl(dash) int(sol) x 10 gdp(sol) c(dash) i(dot)
0.03 0.015 5
0.02
0.01
0.01 0
0.005
0
-0.01 0 -5
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20
-3 -3 -3
x 10 x(sol) m(dash) x 10 n(sol) k(dash) x 10 tightness(sol) v(dash) u(dot)
1 2 5
0 0
1
-1 -5
0
-2 -10
-3 -1 -15
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20
Figure 3: Domestic markup shock
The open economy aspects of our model can be captured by an export demand shock (see Figure 6 ) and a
risk premium shock (Figure 7 ). Both shocks make the labor market tighter. Interestingly, there is a strong effect
of foreign demand to real wages. Though labor market tightness increases, as a result of absence of adjustment
at the intensive margin, employment shifts only modestly. The small drop in consumption is in contrast to
JV2008 and might be the result of monetary tightening and the absence of non-optimizer consumers. In the
case of a risk premium shock our model predicts a drop in real wages which is the opposite as with the model
with monopolistically competitive labor market.
A surprise rise in import prices (see Figure 8 ) works similarly as a negative productivity shock: it leads to
a fall in output and real wages and to higher prices. Again, labor-capital substitution is strong and there is a
slight increase in employment. Finally, the labor market becomes tighter.
In sum, open economy related shocks work similarly as in the model with monopolistically competitive labor
markets, but real wages and consumption.
5.1 Comparison with the model without search-and-matching frictions
The next exercise gives a more detailed view on how our model behaves in comparison to the JV2008 model for
Hungary. For this purpose we compare six impulse responses from the two models. To ensure comparability, we
used the following shocks: a 1 percent improvement in the case of the productivity shock, a 1 percentage point
20
0.01 1 1
0 0.5 0
-0.01 0 -1
0 10 20 0 10 20 0 10 20
-3
pi(sol) -3
x 10 cycl infl(dash) x 10 int(sol) gdp(sol) c(dash) i(dot)
5 4 0.05
0 2 0
-5 0 -0.05
0 10 20 0 10 20 0 10 20
0.01 0.02 0.2
0 0 0
-0.01 -0.02 -0.2

0 10 20 0 10 20 0 10 20
Figure 4: Outside option shock
increase in the (annualized) interest rate for the monetary shock, a domestic markup shock which increases
consumer prices by 1 percent on impact, a 1 percentage point increase in government consumption, a risk
premium shock resulting in an immediate 1 percent depreciation of the nominal exchange rate, and a shock to
nominal wages (an outside option shock in our model, a wage markup shock in JV2008) with an immediate 1
percent impact on nominal wages.
The comparative exercise generally shows that output is much less responsive in this model than in the
benchmark model of JV2008. As mentioned, this can be explained by the lack of adjustment at the intensive
margin (in hours) while in the benchmark model hours more or less move together with output. In addition,
there is a strong substitution between labor and capital, which also creates smoother and weaker output effects.
This feature of our model fits better with the consensus view advocated by other estimated models (summarized
in Vonnák 2007) describing the Hungarian economy than JV2008. In the case of a monetary shock: this model’s
view on how monetary transmission works is again more in line with other models’ predictions: JV2008 generates
a strong reaction in output while it only slightly moves in this model. At the same time disinflationary effects
of a monetary tightening are similar in magnitude in the two models. In the case of risk premium shock the
same applies: output in this model hardly changes, an exogenous depreciation of the currency does not induce
strong expenditure switching effects because capital is crowded out.
21
0.1 0.2 0.5
0 0 0
-0.1 -0.2 -0.5

0 10 20 0 10 20 0 10 20
0.05 0 0.4
0 -0.05 0.2
-0.05 -0.1 0
0 10 20 0 10 20 0 10 20
0.2 0.5 20
0 0 0
-0.2 -0.5 -20

0 10 20 0 10 20 0 10 20
Figure 5: Participation shock
On the other hand, the model with search-and-matching frictions does not really change our picture on
how prices behave, except for the outside option and the government consumption shocks. The similarity in
price-reactions also makes interest rate reactions similar as estimated monetary reaction functions do not differ
too much.
Our model gives a very different picture of the behavior of both nominal and real wages. For example in
the case of risk premium shock this model predicts a drop after four quarters while in the benchmark model
they increase for a substantial time. The decrease in real wages is more in accordance with the findings of
the traditional model of the Magyar Nemzeti Bank (the NEM model, see Benk et al (2006)). An increase in
government spending implies a drop in real wages in the benchmark model, while in this model the opposite
happens. The latter is more in line with the intuition.
Domestic markup shocks have almost the same inflationary consequences (although this is due to how the
shocks are defined), but again output is hardly affected in our model.
The wage markup shock in the JV2008 model and our outside option shock works in very different channels.
In the benchmark model they work directly through the wage Phillips curve, while in this model they enter into
the bargaining process relatively quickly. Hence, though this shock feeds into the Nash-wage at the first stage,
and this would slow down the transmission, due to the low level of wage rigidities real wages move erratically.
22
0.1 0.2 0.5
0 0 0
-0.1 -0.2 -0.5

0 10 20 0 10 20 0 10 20
0.1 0.05 0.2
0 0
-0.1 0 -0.2
0 10 20 0 10 20 0 10 20
1 0.01 0.5
0.5 0 0
0 -0.01 -0.5
0 10 20 0 10 20 0 10 20
Figure 6: Export demand shock

1 0.3 0.4
0.2 0.3
0.5
0.1 0.2
0 0.1
0
-0.1 0
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20

0.3 0.2 0.1
0.2 0.15 0.05
0.1 0.1 0
0 0.05 -0.05
-0.1 0 -0.1
0 5 10 15 20 0 5 10 15 20 0 5 10 15 20

0.1 0.01 0.6
0.05 0.4
0
0 0.2
-0.01
-0.05 0
-0.1 -0.02 -0.2

0 5 10 15 20 0 5 10 15 20 0 5 10 15 20
Figure 7: Risk premium shock
23
0.5 0.2 0.4
0 0 0.2
-0.5 -0.2 0
0 10 20 0 10 20 0 10 20
0.2 0.2 0
0 0.1 -0.2
-0.2 0 -0.4
0 10 20 0 10 20 0 10 20
0.2 0.05 0.5
0 0 0
-0.2 -0.05 -0.5

0 10 20 0 10 20 0 10 20
Figure 8: Import price shock
This can be the reason why while the behavior of nominal wages is similar in the two models, we have stronger
effects on real wages and thus output and inflation are more or less cushioned from the drop.
In sum, comparing the two DSGE models highlights that the models show relatively similar price responses,
while output responses are much smoother in our model and real wages behave rather differently.
5.2 Variance decomposition
We investigated how much of the variance of the endogenous variables individual shocks explain. Table 3
contains a variance decomposition based on the estimated parameters of the model for the 2nd regime.
Variance decomposition reveals that most of the real variables are explained by foreign demand, monetary
policy and government spending shocks. Interestingly, the productivity shock explains only a limited fraction
of the variance of consumption and the real wage. Real and nominal wages are influenced by the outside option
shock, the financial premium, the matching and the domestic markup shock. In the benchmark model real
wages were almost solely explained by the wage markup shock. Thus, this model creates a more intensive link
between real wages and non-labor market related shock than the model with pure monopolistically competitive
labor markets.
24
Inflation (π̂t ) Wage inflation (π̂ w
t
)
0.1 0.2
0.1
0
0
-0.1
-0.1
-0.2
-0.2
-0.3
-0.3
-0.4
-0.4
-0.5 -0.5
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Jakab-Világi (2008) This model Jakab-Világi (2008) This model
GDP Real wages (wt )

2.5 0.25
0.2
2
0.15
1.5
0.1
1
0.05
0.5
0
0
-0.05
-0.5 -0.1
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Nominal interest rate (R̂t ) Nominal exchange rate (êt )

0.05 0.4
0
0.2
-0.05
0
-0.1
-0.2
-0.15
-0.4
-0.2
-0.6
-0.25
-0.3
-0.8
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Figure 9: Comparison of impulse responses: productivity shock
25
t
)
0.1 0.05
0.05 0
0
-0.05
-0.05
-0.1
-0.1
-0.15
-0.15
-0.2
-0.2
-0.25
-0.25
-0.3
-0.3
-0.35 -0.35
-0.4 -0.4
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.1 0.1
0.05 0.05
0 0
-0.05
-0.05
-0.1
-0.1
-0.15
-0.15
-0.2
-0.2
-0.25
-0.3 -0.25
-0.35 -0.3
-0.4
-0.35
-0.45
-0.4
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1.2 0
-0.2
1
-0.4
0.8 -0.6
-0.8
0.6
-1
0.4
-1.2
0.2
-1.4
-1.6
0
-1.8
-0.2
-2
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Figure 10: Comparison of impulse responses: monetary shock
26
t
)
0.2 0.35
0.3
0.15
0.25
0.2
0.1
0.15
0.1
0.05
0.05
0
0
-0.05
-0.05 -0.1
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.3 0.16
0.14
0.25
0.12
0.2
0.1
0.15 0.08
0.06
0.1
0.04
0.05
0.02
0 0
-0.02
-0.05
-0.04
-0.1
-0.06
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.25 1.6
1.4
0.2
1.2
0.15
1
0.1 0.8
0.6
0.05
0.4
0
0.2
-0.05
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Figure 11: Comparison of impulse responses: risk premium shock
27
t
)
0.14 0.045
0.04
0.12
0.035
0.1
0.03
0.08
0.025
0.06 0.02
0.04 0.015
0.01
0.02
0.005
0
0
-0.02
-0.005
-0.04 -0.01
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.2 0.02
0.015
0.15
0.01
0.1
0.005
0.05
0
-0.005
-0.05
-0.01
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.07 0.04
0.06
0.03
0.05
0.02
0.04
0.01
0.03
0
0.02
-0.01
0.01
-0.02
0
-0.01
-0.03
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Figure 12: Comparison of impulse responses: government spending shock
28
t
)
0.012 0.0012
0.001
0.01
0.0008
0.008
0.0006
0.006 0.0004
0.004 0.0002
0
0.002
-0.0002
0
-0.0004
-0.002 -0.0006
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.0005 0
-0.0005
0
-0.001
-0.0005
-0.0015
-0.001
-0.002
-0.0015
-0.0025
-0.002
-0.003
-0.0025
-0.0035
-0.003
-0.004
-0.0035
-0.0045
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.006 0.01
0.005
0.008
0.006
0.004
0.004
0.003 0.002
0.002
0
-0.002
0.001
-0.004
0 -0.006
-0.001
-0.008
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Figure 13: Comparison of impulse responses: domestic markup shock
29
t
)
0.14 1.2
0.12 1
0.1
0.8
0.08
0.6
0.06
0.4
0.04
0.2
0.02
0
0
-0.02 -0.2
-0.04 -0.4
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.02 1.4
0
1.2
-0.02
1
-0.04
-0.06 0.8
-0.08
0.6
-0.1
0.4
-0.12
-0.14 0.2
-0.16
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

0.1 0.1
0.09 0.08
0.08 0.06
0.07 0.04
0.06 0.02
0.05 0
0.04 -0.02
0.03 -0.04
0.02 -0.06
0.01 -0.08
0
-0.1
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Figure 14: Comparison of impulse responses: wage markup shock in Jakab-Világi (2008) and outside option
shock
30
εdt εat εgt εxt εuip
t
εmf
t
εpm
t
εit εlt εm
t
εµt εµx
t
εbt ερt
C ons. ĉt 40.89 2.82 1.62 1.27 11.07 0.16 5.68 3.49 1.60 10.48 15.49 5.37 0.00 0.05
Inv . ı̂t 3.21 1.92 1.36 1.19 3.66 0.31 2.99 71.28 2.94 1.04 5.23 4.76 0.04 0.06
E xp. n̂x,t +ŷ t 0.08 0.39 0.03 96.68 0.04 0.03 0.71 0.50 0.25 0.04 0.04 1.19 0.00 0.01
Im p . n̂t +ŷm,t 5.36 12.84 3.10 59.33 1.91 0.28 2.26 8.85 2.08 1.75 1.08 1.07 0.01 0.07
GDP gdpt 4.32 10.11 10.82 26.31 2.58 0.32 9.69 9.07 2.65 1.69 2.18 20.18 0.00 0.07
R. wage ŵt 1.46 1.12 0.61 2.77 5.56 10.85 2.11 2.28 2.26 8.8 44.49 1.86 15.8 0.04
I n fl . π̂t 0.19 0.64 0.07 1.13 16.47 0.05 1.60 1.02 0.52 5.23 73.03 0.04 0.00 0.02
W i n fl . π̂w 0.45 0.87 0.22 4.72 15.19 20.27 1.17 1.48 1.75 14.26 23.98 0.05 15.57 0.03
t
N . int. R̂t 0.21 0.46 0.06 1.11 19.6 0.06 1.8 1.64 0.71 32.21 42.07 0.06 0.00 0.02
N . e xch êt 1.01 1.41 0.38 0.87 23.69 0.13 4.09 2.24 1.42 9.55 54.39 0.76 0.00 0.04
R . ex ch * êt −p̂t 0.15 0.14 0.06 0.76 65.59 0.05 0.63 2.99 0.6 13.92 14.86 0.23 0.00 0.01
E m p l. n̂t 0.01 0.00 0.00 0.04 0.11 9.5 0.01 0.11 87.47 0.02 0.10 0.00 0.00 2.61
E m p l., d . n̂d,t 3.1 0.55 1.59 48.1 1.06 3.36 0.8 5.09 31.4 1.22 1.10 1.72 0.00 0.91
E m p l., x . n̂x,t 3.73 0.7 1.95 64.26 1.97 1.62 1.01 5.18 14.52 1.21 1.02 2.36 0.01 0.46
U n em p l. ût 0.00 0.00 0.00 0.02 0.04 3.57 0.00 0.04 95.29 0.01 0.04 0.00 0.00 0.98
Vac. vt 0.03 0.03 0.01 0.19 0.47 14.24 0.04 0.14 83.6 0.09 0.17 0.01 0.01 0.98
* pt denotes consumer price level (cumulated inflation)
Table 3: Unconditional variance decomposition
On the other hand, the domestic markup shock captures large shifts in the VAT-rate, food prices and
regulated prices. This shock explains a larger part of the inflation variance than in the benchmark JV2008
model. Hence, this model is more successful in explaining nominal wage inflation, while it is less so with respect
to inflation. The risk premium (exchange rate movements on top of the UIP) also has a large impact on inflation.
This reinforces that a exchange rate channel works as a strong transmission channel of monetary policy.
Interestingly, aggregate employment is explained by participation shocks. However, sectoral employments
are influenced by other shocks as well. This might point to some problem in the model: sectoral flows are very
intensive and there are large sectoral reallocations.
Turning to labor market related shocks, we find that the outside option shock (εbt ) influences nominal and
real wages. However, it does not translate into large employment fluctuations. The participation shock (εlt ) has
a large impact on unemployment and employment and sectoral employments. Hence, large shifts in inactivity
translate into employment dynamics in Hungary. The shock to matching (εmf
t
) has an impact primarily on
wages.
The main conclusion from this section, therefore, is that foreign demand shocks, monetary, risk premium,
preference, government expenditure and productivity shocks are very important for all variables. Labor market
related shocks help in understanding wages and employment, but their impact on other variables is rather
limited.
31
6 Conclusions
This paper presented an estimated DSGE model of the Hungarian economy with search-and-matching frictions.
Our primary goals with this exercise were to (i) examine the role of the labor market in the monetary transmission
mechanism, (ii) look at the role of labor market shocks on the general economy, and (iii) examine the impact of
foreign shocks on the labor market. The small open economy nature of our model allowed us to carry out the
last exercise, which to the best of our knowledge is new in the literature.
Our results show that the structure of the labor market has a significant impact on monetary transmission.
Shocks originating from the labor market, however, were not particularly important determinants of variables
outside the labor market in our estimation period. This does not mean that labor market disturbances are
irrelevant, but their effect probably operates on a longer horizon than what our model captures.
Foreign shocks, especially to export demand and to the exchange rate, play an important role in the Hun-
garian economy. Such shocks influence wage determination, and very heavily impact on the sectoral allocation
of employment. This latter feature is probably an artifact of our assumption of perfect substitutability of labor
across sectors, and indicates that sectoral adjustment costs may be important in the Hungarian economy.
Finally, comparing our estimates to an earlier DSGE model of the Hungarian economy reveals that our
structurally more rigid labor market leads to a more realistic picture of the Hungarian economy. In particular,
we find smaller output responses to various shocks, which is more in line with non-DSGE evidence for Hungary.
References
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of Monetary Economics, 50, p 1189-1214.
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Policy in an Estimated DSGE Model". ECB Working Paper No. 635.
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2007/3, Magyar Nemzeti Bank.
Appendix
A The log-linearized model
Households
1. Euler equation (λ)

R̂t = λ̂t − Et λ̂t+1 + Et π̂ t+1
33
2. Marginal utility of income (c)
ϑ
λ̂t = − (ĉt − hĉt−1 ) + εct
1−h
3. Capital-bond trade-off (Q)
k
Q̂t = β (1 − δ) Et Q̂t+1 + [1 − β (1 − δ)] Et r̂t+1 + Et λ̂t+1 − λ̂t
4. Investment (i)
1 β 1 βEt εIt+1 − εIt
ît = ît−1 + Et ît+1 + Q̂t +
1+β 1+β (1 + β) φ′′ (1) 1+β
5. Capital accumulation (k)

k̂t = (1 − δ) k̂t−1 + δı̂t − n̂t + (1 − δ) n̂t−1
Wholesale production
1. Production function intensive form (y)
ŷt = αk̂t−1 + αz (1 − α) ŷm,t + at
2. Capital demand (rk )

k̂t−1 = p̂w,t + ŷt − r̂tk
3. Import demand (ym )
ŷm,t = p̂w,t + ŷt − p̂m,t
p̂m,t = p̂∗m,t + êt − p̂t
The labor market
1. Net output definition (ξ)

ξ̂ t = p̂w,t + ŷt
2. Employment (n)
n̂t = ρ̄m̂t + (1 − ρ̄) n̂t−1 − ρ̄ρ̂t
3. Unemployment (u)
ūt ût = L̄L̂t − n̄n̂t−1
34
4. Matching function (m)
m̂t = σv̂t + (1 − σ) ût + εmf
t
5. Labor market tightness (v)

θˆt = v̂t − ût
6. Job finding rate (s)

ŝt = σθ̂ t + εmf
t
7. Job filling rate (q)

q̂t = (σ − 1) θ̂t + εmf
t
8. Newly set wage

∗ s̄ϑw
∗ βγ w (1 − ρ̄)
ŵt∗ = ω̂t + Et ŵt+1 − ŵt∗ − Et ŵt+1 − ŵt
(1 − ρ) γ w 1 − βγ w (1 − ρ̄)
9. Nash wage (ω)

βκ̄θ̄ χ̄
w̄ω̂ t = η ξ̄ ξ̂ t + Et θ̂t+1 − λ̂t + (1 − η) χ̂t − λ̂t
λ̄ λ̄
10. Average wage

ŵt = [ρ̄ϑw + (1 − ρ̄) γ w ] ŵt−1 + [1 − ρ̄ϑw − (1 − ρ̄) γ w ] ŵt∗
11. Wage Phillips curve (π w )
β [(1 − ρ̄) γ w − s̄ϑw ] [1 − ρ̄ϑw − (1 − ρ̄) γ w ] [1 − βγ w (1 − ρ̄)]

π̂ w
t = Et π̂w
t+1 + (ω̂ t − ŵt + p̂t )
ρ̄ϑw + (1 − ρ̄) γ w ρ̄ϑw + (1 − ρ̄) γ w
12. Nominal wage (w)

π̂w
t = ŵt − ŵt−1
13. Job creation (θ)
λ̄q̄

q̂t = β (1 − ρ) Et q̂t+1 − ξ̄ ξ̂ t − w̄ω̂ t + ξ̄ − ω̄ λ̂t
κ
λ̄q̄ϑw w̄
+ Et β (1 − s̄) π̂w w
t+1 − π̂ t + βρ̄Et ρ̂t+1
κ [1 − βγ w (1 − ρ)] [1 − ϑw ρ − γ w (1 − ρ)]
35
Domestic equilibrium
1. Domestic Phillips curve (π)
(1 − γ) (1 − βγ)
dπ̂t − ϑp dπ̂ t−1 = β (Et dπ̂t+1 − ϑp dπ̂t ) + (p̂w,t + µ̂t )
γ
2. CPI (p)
π̂t = p̂t − p̂t−1
3. Domestic equilibrium (pw )

n̄d ȳ (n̂d,t + ŷt ) = c̄ĉt + ı̄ı̂t + ḡĝt
4. Labor market (nd )

n̄n̂t = n̄d n̂d,t + n̄x n̂x,t
5. Taylor rule (R)

R̂t = ξ r R̂t−1 + (1 − ξ r ) (ξ π Et π̂ t+1 + ξ e êt ) + εm
t
External equilibrium
1. Export sector Phillips curve (π x )

(1 − γ x ) (1 − βγ x )
π̂xt − ϑx π̂xt−1 = β Et π̂xt+1 − ϑx π̂xt + (p̂w,t − p̂x,t − êt + p̂t + µ̂t )
γx
2. Export price (px )

π̂xt = p̂xt − p̂xt−1
3. Export demand (nx )

n̂x,t + ŷt = −θx p̂x,t + εxt
4. Current account (db)

βdbt − dbt−1 = p̄x n̄x ȳ (p̂x,t + ŷt + n̂x,t ) − p̄m ȳm p̂∗m,t + ŷm,t + n̂t
5. UIP (e)
R̂t = Et êt+1 − êt − βψdbt + εuip
t
36
B Steady state
1. Normalizations
ē = 1
p̄x = p̄ = 1
ȳ = 1
2. Households
1
r̄k = −1+δ
β
ı̄ = δ k̄n̄
−ϑ −ϑ
λ̄ = (1 − h) c̄
3. Production
1
p̄w =
1 + µ̄
ȳ = k̄α ȳm
αz (1−α)
r̄k k̄ = αp̄w ȳ
p̄m ȳm = αz (1 − α) p̄w ȳ
4. Labor market
m̄ = ρn̄
n̄ + ū = 1
σ−1
q̄ = σm θ̄
κ̄
[1 − β (1 − ρ)] = (1 − α) (1 − αz ) p̄w ȳ − w̄
λ̄q̄

βκ̄θ̄ χ̄
w̄ = η (1 − α) (1 − αz ) p̄w ȳw + + (1 − η) bu +
λ̄ λ̄
37
5. Equilibrium
n̄d ȳ = c̄ + ı̄ + ḡ
1−hx −θ x
[(n̄ − n̄d ) ȳ] = (p̄x ) Yw
n̄p̄m ȳm = p̄x (n̄ − n̄d ) ȳ
C Labor market derivations6
Firms
• Firm surplus for a newly set wage
λt+1

∗
Jt (wt∗ ) = ξ t − wt∗ + βEt 1 − ρt+1 γ w Jt+1 (wt∗ ) + (1 − γ w ) Jt+1 wt+1
λt

∗ ∗ λt+1

∗
∗
Jt wt−1 = ξ t − wt−1 + βEt 1 − ρt+1 γ w Jt+1 wt−1 + (1 − γ w ) Jt+1 wt+1
λt

∗
λt+1

∗
Jt (wt∗ ) − Jt wt−1 = − wt∗ − wt−1
∗
+ βγ w Et 1 − ρt+1 Jt+1 (wt∗ ) − Jt+1 wt−1
λt
∞
j

∗ λt+j j

∗
= − wt − wt−1 Et (βγ w ) 1 − ρt+s
j=0
λt s=1
λt+1

∗
Jt (wt∗ ) = ξ t − wt∗ + βEt 1 − ρt+1 Jt+1 wt+1
λt
∞
j

∗ ∗
λt+j j

+Et wt+1 − wt (βγ w ) 1 − ρt+s
j=1
λt s=1
• New hires without newly set wages
λt+1

∗
Jt (wt−1 ) = ξ t − wt−1 + βEt 1 − ρt+1 γ w Jt+1 (wt−1 ) + (1 − γ w ) Jt+1 wt+1
λt
λt+1

Jt (wt∗ ) − Jt (wt−1 ) = − (wt∗ − wt−1 ) + βγ w Et 1 − ρt+1 [Jt+1 (wt∗ ) − Jt+1 (wt−1 )]
λt
∞
j
λt+j j

∗
= − (wt − wt−1 ) Et (βγ w ) 1 − ρt+s
j=0
λt s=1
∞
j
λ t+j j

Jt (wt−1 ) = Jt (wt∗ ) + (wt∗ − wt−1 ) Et (βγ w ) 1 − ρt+s
j=0
λt s=1
6 Note that we derive results with real instead of nominal wage rigidity to save on notation. To convert the equations here to the
case of nominal wage rigidity, it is enough to redefine π̂ w w

t as nominal wage inflation, and accordingly write π̂ t = ŵt − ŵt−1 + π̂ t .
38
• Vacancy condition
κ
Vt = − + qt [ϑw Jt (wt−1 ) + (1 − ϑw ) Jt (wt∗ )]
λt
∞
j
κ λt+j j

∗ ∗
= − + qt Jt (wt ) + qt ϑw (wt − wt−1 ) Et (βγ w ) 1 − ρt+s
λt j=0
λt s=1
∞
j
κ λt+j j

∗ ∗
= Jt (wt ) + ϑw (wt − wt−1 ) Et (βγ w ) 1 − ρt+s
λt qt j=0
λt s=1
• Value of a job once more
∞
j

∗ λt+j j

Jt (wt∗ ) = ξ t − wt∗ ∗
+ Et wt+1 − wt (βγ w ) 1 − ρt+s
j=1
λt s=1
λt+1

∗
+βEt 1 − ρt+1 Jt+1 wt+1
λt
∞
j
∗

∗ ∗
λt+j j

= ξ t − wt + Et wt+1 − wt (βγ w ) 1 − ρt+s
j=1
λt s=1
 j 
∞
λt+1
κ
∗ λt+j+1 j

+βEt 1 − ρt+1  − ϑw wt+1 − wt (βγ w ) 1 − ρt+s 
λt λt+1 qt+1 j=0
λ t+1 s=1

λt+1 κ 1 − ρt+1
= ξ t − wt∗ + βEt
λt λt+1 qt+1
∞ j

∗ ∗
ϑw
∗ λt+j j

+ Et wt+1 − wt − wt+1 − wt (βγ w ) 1 − ρt+s
γw j=1
λt s=1
• Job creation

κ β 1 − ρt+1 κ
= ξ t − wt∗ + Et
λt qt λt qt+1
∞ j

∗ ∗
ϑw
∗ λt+j j

γw j=1
λt s=1
∞
j
λt+j j

∗
+ϑw (wt − wt−1 ) (βγ w ) 1 − ρt+s
j=0
λt s=1
Workers
• Newly set wages
39
λt+1

∗
Wt (wt∗ ) = wt∗ + βEt 1 − ρt+1 γ w Wt+1 (wt∗ ) + (1 − γ w ) Wt+1 wt+1 + ρt Ut+1
λt

∗ ∗ λt+1

∗
∗
Wt wt−1 = wt−1 + βEt 1 − ρt+1 γ w Wt+1 wt−1 + (1 − γ w ) Wt+1 wt+1 + ρt+1 Ut+1
λt

∗ λt+1

∗
Wt (wt∗ ) − Wt wt−1 = ∗ ∗
wt − wt−1 + βγ w Et 1 − ρt+1 Wt+1 (wt∗ ) − Wt+1 wt−1
λt
∞
j

∗ ∗
λt+j j

= wt − wt−1 (βγ w ) 1 − ρt+s
j=0
λt s=1
j
λt+j j

Wt (wt∗ ) = ∗
wt + βEt (βγ w ) 1 − ρt+s
λt s=1
• New jobs but wages not reset (derivation same as for firms)
∞
j

λt+j j

Wt (wt−1 ) = Wt (wt∗ ) − (wt∗ − wt−1 ) (βγ w ) 1 − ρt+s
j=0
λt s=1
• Unemployment and net gain
χt λt+1
∗
Ut = bu + + βEt st+1 ϑw Wt+1 (wt ) + (1 − ϑw ) Wt+1 wt+1 + (1 − st+1 ) Ut+1
λt λt
χt λt+1
∗
= bu + + βEt st+1 Wt+1 wt+1 + (1 − st ) Ut+1
λt λt
∞
j

∗ λt+j+1 j

−βϑw Et st+1 wt+1 − wt (βγ w ) 1 − ρt+s
j=0
λt s=1
χt λt+1
∗
= bu + + βEt st+1 Wt+1 wt+1 + (1 − st ) Ut+1
λt λt
∞
j
st+1 ϑw
∗ λt+j j

−Et
wt+1 − wt (βγ w ) 1 − ρt+s
1 − ρt+1 γ w j=1
λt s=1
χ λt+1
∗
Wt (wt∗ ) − Ut = wt∗ − bu − t + βEt (1 − ρ − st+1 ) Wt+1 wt+1 − Ut+1
λt λt
∞ j

∗ st+1 ϑw
λt+j j

− Et wt+1 − wt∗ − Et
∗
wt+1 − wt (βγ w ) 1 − ρt+s
1 − ρt+1 γ w j=1
λt s=1
Wage setting
Wage equation derivation

max [Wt (wt∗ ) − Ut ]η Jt (wt∗ )1−η
ηJt (wt∗ ) = (1 − η) [Wt (wt∗ ) − Ut ]
40

j 
 ∞ 
λ t+1 κ 1 − ρ
ϑw
λt+j

η ξ t − wt∗ + βEt t+1
+ Et wt+1∗
− wt∗ − ∗
wt+1 − wt (βγ w )j 1 − ρt+s =
 λt λt+1 qt+1 γw j=1
λt s=1

 ∞ j 
 χ
s ϑ
λ

t+1 w t+j
= (1 − η) wt∗ − bu − t − Et wt+1 ∗
− wt∗ − Et
∗
wt+1 − wt (βγ w )j 1 − ρt+s
 λt 1 − ρt+1 γ w j=1
λt s=1


λt+1
∗
+ηβEt 1 − ρt+1 − st+1 Jt+1 wt+1
λt
 j 
 ∞ 
βκ
ϑw
λt+j

η ξ t − wt∗ + ∗
Et θt+1 + Et wt+1 − wt∗ − ∗
wt+1 − wt (βγ w )j 1 − ρt+s =
 λt γw j=1
λt s=1

 ∞ j 
 χ
s ϑ
λ

t+1 w t+j
= (1 − η) wt∗ − bu − t − Et wt+1 ∗
− wt∗ − Et
∗
 λt 1 − ρt+1 γ w j=1
λt s=1

∞
j

λt+1
∗ λt+j+1 j

−ηβEt 1 − ρt+1 − st+1 ϑw wt+1 − wt (βγ w ) 1 − ρt+s
λt j=0
λt+1 s=1
 j 
 ∞ 
βκ
ϑw
λt+j

η ξ t − wt∗ + Et θt+1 + Et wt+1∗
− wt∗ − ∗
wt+1 − wt (βγ w )j 1 − ρt+s =
 λt γw j=1
λt s=1

 ∞ j 
 χ
st+1 ϑw
λt+j

= (1 − η) wt∗ − bu − t − Et wt+1 ∗
− wt∗ − Et
∗
 λt 1 − ρt+1 γ w j=1
λt s=1


∞
j
1 − ρt+1 − st+1 ϑw
∗ λt+j j

−ηEt
wt+1 − wt (βγ w ) 1 − ρt+s
1 − ρt+1 γ w j=1
λt s=1
Wage equation

βκ χt
wt∗ = η ξt + Et θt+1 + (1 − η) b +
λt λt
∞
j

λt+j j

st+1 ϑw

∗
+Et (βγ w ) 1 − ρt+s wt+1 − wt∗ −
∗
wt+1 − wt
j=1
λ t s=1
1 − ρt+1 γ w
Job creation
• Recall from earlier

κ β 1 − ρt+1 κ
= ξ t − wt∗ + Et
λt qt λt qt+1
∞ j

∗ ∗
ϑw
∗ λt+j j

γw j=1
λt s=1
∞
j
λt+j j

∗
+ϑw (wt − wt−1 ) (βγ w ) 1 − ρt+s
j=0
λt s=1
41
• Define the Nash wage as

βκ χ
ωt = η ξ t + Et θt+1 + (1 − η) bu + t
λt λt
• Job creation condition

κ β 1 − ρt+1 κ
= ξ t − ω t + Et
λt qt λt qt+1
∞
j
λt+j j

(1 − st+1 ) ϑw
∗
−Et (βγ w ) 1 − ρt+s
wt+1 − wt
λt s=1
1 − ρt+1 γ w
j=1
∞
j

λt+j j

∗
+ϑw (wt − wt−1 ) (βγ w ) 1 − ρt+s
j=0
λt s=1
42

An Open Economy DSGE Model With Search-And-matching Frictions

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An Open Economy DSGE Model With Search-And-matching Frictions

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An open economy DSGE model with search-and-matching frictions:

the case of Hungary

Zoltán Jakab∗and István Kónya†

models without search-and-matching frictions.

2.2 The wholesale sector

2.2.1 Job flows

The value of a job when the wage is just negotiated is given by

2.2.4 Wage bargaining

(1 − η) [Wt (wt∗ ) − Ut ] = ηJt (wt∗ ) . (14)

2.2.5 Average wages

β [(1 − ρ̄) γ w − s̄ϑw ] [1 − ρ̄ϑw − (1 − ρ̄) γ w ] [1 − βγ w (1 − ρ̄)]

2.2.6 Job creation

2.3 Final goods

This implies the following first order condition:

dπ̂ ≡ π̂t − π̂pt .

Aggregate capital is the sum of firm-level capital,

Monetary policy is represented by a simple Taylor rule:

r̂t = ζ r r̂t−1 + (1 − ζ r ) (ζ π Et π̂t+1 + ξ e êt ) + εm

where et /pt is the real exchange rate.

3.1 Non-labor market parameters

Table 1: Calibrated parameter values outside the labor market

3.2 Labor market parameters

4.1 Specifying prior distributions

4.2 Estimation results

Table 2: Estimated parameters

5 Impulse response analysis

-0.1 -0.1 -0.2

-0.2 -0.2 -0.4

-0.3 -0.3 -0.6

pi(sol) cycl infl(dash) int(sol) gdp(sol) c(dash) i(dot)

-0.1 -0.1 0.2

-0.3 -0.2 -0.2

x(sol) m(dash) n(sol) k(dash) tightness(sol) v(dash) u(dot)

Figure 1: Productivity shock

e(sol), reer(dash) real w(sol) Nash wage(dash) nom. wage infl(sol)

pi(sol) cycl infl(dash) int(sol) gdp(sol) c(dash) i(dot)

x(sol) m(dash) n(sol) k(dash) tightness(sol) v(dash) u(dot)

Figure 2: Monetary shock

Figure 3: Domestic markup shock

5.1 Comparison with the model without search-and-matching frictions

-0.01 -0.02 -0.2

Figure 4: Outside option shock

-0.1 -0.2 -0.5

-0.2 -0.5 -20

Figure 5: Participation shock

-0.1 -0.2 -0.5

Figure 6: Export demand shock

e(sol), reer(dash) real w(sol) Nash wage(dash) nom. wage infl(sol)

pi(sol) cycl infl(dash) int(sol) gdp(sol) c(dash) i(dot)

0.2 0.15 0.05

x(sol) m(dash) n(sol) k(dash) tightness(sol) v(dash) u(dot)

-0.1 -0.02 -0.2

Figure 7: Risk premium shock

-0.2 -0.05 -0.5

Figure 8: Import price shock

5.2 Variance decomposition

Jakab-Világi (2008) This model Jakab-Világi (2008) This model

GDP Real wages (wt )

Jakab-Világi (2008) This model Jakab-Világi (2008) This model

Nominal interest rate (R̂t ) Nominal exchange rate (êt )

Jakab-Világi (2008) This model Jakab-Világi (2008) This model

Figure 9: Comparison of impulse responses: productivity shock

Jakab-Világi (2008) This model Jakab-Világi (2008) This model

GDP Real wages (wt )