Research Technical Paper: Economic Migration and Business Cycles in a Small Open Economy with Matching Frictions

The Central Bank of Ireland has published a Research Technical Paper (PDF 1.04MB).

The paper, “Economic Migration and Business Cycles in a Small Open Economy with Matching Frictions”, by Matija Lozej, investigates how the domestic labour market of a small open economy is affected by migration and the implications this has on the business cycle of a small open economy.

The key findings of the Research Technical Paper are:

• Contrary to widespread beliefs, migration can amplify cyclical fluctuations. The reason for amplification is that migration affects labour supply.
• After a positive shock to the home economy, the labour force increases due to immigration, which dampens the wage increase and the corresponding increase in firms' marginal costs. Firms become more profitable and post more vacancies, which increases employment, output, and attracts new workers to the economy. Attenuated response of wages and stronger response of employment to domestic shocks result in flatter Phillips curve when migration is sizeable.
• The impact of migration on the home labour market depends both on the relative size of the home economy and its openness to migration. When an economy is small and open to migration towards a large region, the size of its labour market is small relative to size of the pool of potential migrants. In such case, migration can significantly amplify country-specific shocks.
• An increase in immigration due to adverse shocks abroad can increase unemployment. This increase is temporary if wages adjust so that firms post more vacancies and those unemployed find work. Additional net government spending associated with unemployment benefits for newcomers is quickly reversed due to higher tax collections. When wages do not adjust to immigration, unemployment persists and net government spending on unemployment benefits is not offset by the increase in labour tax revenues.

Notes

The views presented in Research Technical Papers are those of the authors alone and do not necessarily represent the official views of the Central Bank of Ireland.