Analyzing Structural Reforms Using a Behavioral Macroeconomic Model

We use a behavioral macroeconomic model to analyze how structural reforms affect the economy in the short and in the long run. We consider two types of structural reforms. The first one increases the flexibility of wages and prices; the second one raises potential output in the economy. We find that structural reforms that increase the flexibility of wages and prices can have profound effects on the dynamics of the business cycle. In addition, a structural reform program that raises potential output has a stronger long-term effect on output and tends to reduce the price level more in a flexible than in a rigid economy. Finally, we analyze how structural reforms change the tradeoffs between output and inflation variability. Our main finding here is that there is an optimal level of flexibility (produced by structural reforms).