Desarrollo de la sesión s ¿cómo se inicia?

The Asian and Russian crises of 1997 and 1998 had significant repercussions to the emerging world as the foreign investors’ confidence decline triggered currency depreciations and sharp in- creases in Latin-American country-risk premia. The turmoil in emerging economies, coupled with fears of the return of uncontrolled inflation forced Brazil’s monetary authority to keep interest rates consistently above20%throughout 1997-1999, with rates being as high as42%during the peak of the Asian Financial crisis in Nov/1997.

Despite the turbulence in the emerging world in the 1990s, Brazil’s economy managed to keep a positive, albeit mediocre, growth rate. However, in 2002, Argentina defaulted on its sovereign debt after a long and harsh recession. In addition, the possibility that a far-left candidate, Mr. Lula da Silva, could win Brazil’s presidential elections sparked a confidence crisis that plunged investment and job creation. Inflation, which at that point seemed a problem of the past, loomed at uncomfortably high levels -5%in July 2002 alone - and fueled the fear that Mr. Lula da Silva, if elected, would curb the central bank’s inflation targeting mandate, effectively choosing a soft default via inflation instead of Argentina’s hard default.

Country-risk premium during the 2002 confidence crisis reached remarkable2,400basis points, all but precluding the government’s ability to finance its debt, which led to an emergency loan with the IMF. As the election of Mr. Lula da Silva grew increasingly likely, he issued a public statement, the now famous “Letter to the Brazilian people,” in which he committed his economic policy to the continuity of previous years’ macroeconomic tripod: fiscal primary surplus, floating exchange rates and inflation targeting.

The candidate’s strong signal that his government would not disrupt economic policies that helped stabilize the country post-hyperinflation reassured investors and, by the second quarter of 2003, the economy was on a path of strong growth that would be briefly interrupted by the 2008 Financial crisis.

Figures A.16 and A.17 depict labor and wage, and output, investment and consumption through- out 2000-2017. The leftmost shaded area indicates the 2002 recession. The small decline in output despite sharp drops in consumption and investment is due to a significant improvement in the trade balance, which rose from−2.2%in 2001 to2.2%in 2003, as share of GDP. Trade balance in 2002 was0.8%of GDP.

Real wage declined in both sectors (Figure A.16) though more abruptly in the informal sector. Formal-sector labor declined quickly whereas informal labor was low and remained low during the recession. As economic conditions improved, low wages in the informal sector contributed to the vertiginous rise in informal labor during the recovery that started in 2003. Formal-sector labor also improved in the aftermath of the recession though at a more moderate rate.

In the context of our model economy, we interpret the 2002 recession as a sequence of negative shocks to the short-memory productivity process after a long period of negative but small long- memory TFP shocks. Since the confidence crisis was fueled by international conditions rather than issues in the fundamentals of the domestic economy and the recovery started despite the absence of structural reforms, it is reasonable to think of the crisis as negative shocks to the short-memory process. The long sequence of small negative shocks to the long-memory TFP process refers to the high unemployment, high interest rates and low investment that characterized the 1998-2001 period.

On the other hand, the recovery from the 2002 recession prompted a rise in labor and wages that lasted several years, indicating that the recovery was most likely triggered by a rise in long- memory productivity. To investigate the dynamics of labor, wages, and other macroeconomic variables as the economy recovers, we compute simulated paths for the macro variables under the FGTS and quadratic adjustment models, and, for reference, under a standard RBC which we will use as a benchmark “frictionless” economy. The sequence of shocks follow a 36-month-long decline in long-memory productivity: we generate a sequence starting atεm_t−36 = 0toεm_t = −1.5

in 36equal increments and a quarter of large negative shocks to the short-memory productivity, εs_t−3 =εst−2 =εst−1 =−1.

To compute the theoretical response of a long-memory TFP shock after the sequence of shocks described, we simulate two paths of each macro variable: one with a1-s.d. shock att+1,εm

t+1 = 1,

and zeros afterwards, εm

t+j+1 = 0 ∀j > 0; and another with zeros after the recession, εmt+j =

0 ∀j > 0. To make our exposition clear, we refer to the former and latter as the impulse and

counterfactual series respectively. We denote the impulse-response of a variable as the percent difference between its implied value under the impulse and counterfactual series. For reference, standard impulse-responses, typically interpreted in terms of deviations from steady states, assume a counterfactual series in which no shock hits the system, hence all variables in steady state. For the simulated paths, we set parameters to their posterior means from Table A.5.

Figure A.24 depicts the responses of labor, wages, investment, consumption and output. Com- pared to the frictionless model, both FTGS and quadratic adjustment models dampen the response

of formal-sector labor but the quadratic model imposes a much smoother rise in the labor level than the FGTS. Note that the economy is coming out of a recession and labor level is depressed by the previous sequence of negative productivity shocks. Since the cost of adjusting labor is proportional to last period’s labor level, the decline in labor decreases the adjustment cost under the quadratic model. The stifling effects of the quadratic specification are strong enough that despite the advan- tage of a temporary low labor level, the response under the quadratic model is still significantly muted relative to that of the FGTS.

The decline in labor during the recession also decreases the adjustment cost under the FGTS policy. However, unlike the quadratic adjustment cost, in which the cost of increasing or decreasing the labor force by 1%has a one-to-one relation with the labor level itself, a one-percent increase in the labor level raises FGTS holdings byζ0 = 0.08%, all else constant. This feature explains the

discrepancies in the decay rate across models after formal-sector labor peaks, about five months after the impulse. Quadratic adjustment implies labor barely changes between five and twelve months after the impulse whereas the decay rate implied by the FGTS model is roughly the same as the standard RBC model. Because only a fraction of the labor increase was passed on to the FGTS holdings, the cost of reducing labor is much lower than that implied by the quadratic model hence the more flexible response of labor under the FGTS model.

The FGTS and quadratic models also have considerably different implications for the informal sector. The responses of informal-sector labor and wages under the FGTS model are identical to those of a standard RBC. Interestingly, quadratic adjustment on formallabor significantly stifles the responses of informal labor and wage. To understand why this happens, first note no-arbitrage in the physical capital market implies equal ex-ante returns to capital across sectors. Because adjusting formal labor is costly, agents expect the increase in formal labor to be small when TFP rises. If agents expect a lower labor-capital ratio7 in the formal sector, they allocate physical capital away from that sector and towards the informal sector. This reallocation of capital towards the informal sector is depicted in the third panel from the top in Figure A.24.

Since the quadratic model implies small-magnitude fluctuations in labor relative to the FGTS model, the magnitude of movements in investment will also be smaller under the quadratic model. But both models predict a reallocation of capital towards the informal sector.

While the response of informal labor under the quadratic adjustment model does show a spike on impact with faster decay than in the formal sector, the stifled responses of labor and wages seem to contradict the strong recovery that started in 2003. In the data, informal-sector labor and wages rose sharply in 2003 whereas formal labor delayed a few months to pick up and formal-sector wages recovered more moderately than their informal sector counterparts.

Naturally, the observed labor and wage series are the result of a combination of shocks that preclude the direct interpretation of realized series in terms of theoretical impulse responses. Nev- ertheless, an adjustment cost specification that imposes strong constraints on the responses of informal-sector labor and wages such as the quadratic model seems unwarranted, in particular because the greater flexibility of the informal sector was the motivation for a two-sector model to begin with. We now discuss the recession that followed the 2008 financial crisis.