Sara Naranjo-Saldarriagaa, 
We extend the semi-structural model for monetary policy analysis and forecasting in Colombia, the 4GM model (González et al., 2020), by integrating labor market dynamics into its specification. We incorporate four key mechanisms: (1) wage-price feedback and its effects on marginal costs; (2) the impact of the NAIRU on potential output; (3) Okun’s law to connect cyclical unemployment to the output gap; and (4) the impact of real wages and unemployment on aggregate demand. Our model adds to the baseline 4GM model interactions between goods and labor markets, which affect the transmission of the monetary policy. Focusing on Colombia, a country with a labor market characterized by rigidities and persistently high unemployment, we demonstrate how wage dynamics and labor market tightness amplify inflationary pressures and delay adjustment. Our model aids in disentangling supply and demand shocks, particularly during crises (e.g., the pandemic), when labor market idiosyncrasies distort wage and inflation trends
The most recent
Approach
This study updates the 4GM model used by the Banco de la República de Colombia for monetary policy analysis. The update explicitly integrates labor market dynamics by incorporating the evolution of the unemployment rate and wages. The aim is to capture how labor market conditions interact with economic activity and inflation in Colombia.
Contribution
The new model (4GM+LM) allows for a joint analysis of the evolution of unemployment, wages, growth, and inflation. This enhances the ability to identify the sources of inflationary pressures, distinguish between supply and demand shocks, and assess the degree of slack in the economy, including during periods when the labor market and growth exhibit atypical behavior, as they did during the COVID-19 pandemic. This study provides a more comprehensive analytical tool for economic policymakers.
The 4GM update explicitly integrates the unemployment rate and wages as core variables in the analysis of inflation and monetary policy in Colombia.
Results
Estimating the 4GM+LM model reveals that wage and unemployment shocks can have significant and persistent effects on inflation and on economic activity. The model quantifies the monetary policy responses to such shocks. Furthermore, model evaluation suggests improved predictive ability compared to its predecessor, capturing the high persistence of unemployment in Colombia and the role of the minimum wage as a factor influencing overall wage dynamics. Finally, historical analysis using the model illustrates how different shocks—such as the global financial crisis, fall in oil prices, and the pandemic—affected activity, unemployment, and prices in Colombia, and how monetary policy responded in each case.