https://macropaperwarehouse.com/authors/patrick-kehoe/Patrick KehoeHugo -- gohugo.ioen-ushttps://macropaperwarehouse.com/papers/the-macroeconomic-dynamics-of-labor-market-polices/https://macropaperwarehouse.com/papers/the-macroeconomic-dynamics-of-labor-market-polices/<p>This paper builds a dynamic macroeconomic model with rich worker heterogeneity, firm monopsony power and putty-clay adjustment frictions in order to trace the <em>time path</em> of the effects of the federal minimum wage and the Earned Income Tax Credit, rather than comparing steady states. The putty-clay structure — capital is CES ex ante but Leontief once installed — reconciles the small short-run employment elasticities documented in the minimum-wage literature with the large long-run elasticities of substitution estimated by Katz and Murphy (1992) and Card and Lemieux (2001), and it means firms adjust their input mix only as old capital depreciates. The paper&rsquo;s key result is that the welfare impact of these policies &ldquo;cannot be inferred from evidence on their short-run effects alone&rdquo;: both an increase in the minimum wage and an expansion of the EITC make low-wage workers better off in the first few years, but at longer horizons small minimum-wage increases and EITC expansions of any size continue to help them while sufficiently large minimum-wage increases hurt them, because firms substitute away from workers whose wage is pushed well above the efficient level. Quantitatively, in the baseline parameterisation (a targeted wage markdown of 0.75 and within-education-group substitution elasticity ϕ = 4), an $8.50 minimum wage raises non-college employment by about 0.8% in the long run while a $15 minimum wage lowers it by about 12.1%, with employment falling for all non-college workers initially earning under $11 — 26% of non-college workers; a budget-equivalent EITC instead raises non-college employment by 5.9%, and only about one-fifth of the long-run employment decline from a $15 minimum wage materialises in the first two years. The authors also find that combining the EITC, or the broader U.S. tax and transfer system, with a moderate minimum-wage increase supports low-wage workers better than either policy alone, &ldquo;because doing so more effectively offsets firms&rsquo; monopsony power,&rdquo; and that a minimum wage fixed in nominal terms — as U.S. federal policy is — has small long-run real effects because inflation and productivity growth erode it before firms find it worth re-tooling.</p>