The Macroeconomic Dynamics of Labor Market Policies

Abstract

We develop a dynamic macroeconomic framework with worker heterogeneity, putty-clay capital adjustment frictions, and firm monopsony power to study the distributional impact of labor market policies over time. Our framework reconciles the well-known tension between low short-run and high long-run elasticities of substitution among inputs of production, especially among workers within the same education group. We use this framework to evaluate the effects of redistributive policies such as the minimum wage and the Earned Income Tax Credit, and show that an accurate assessment of their overall impact requires taking into account the entire time path of the responses they induce.