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the negative capital deviation feeds back into to the persistent negative deviation in
the working age population in Fig. 16.7 .
Returning to Fig. 16.5 , the negative deviation in the working age population
exerts a damping effect on regional employment in the post-event phase. In 2014,
the deviation in the working age population is
0.17 %. If wages were fully
flexible, the 2014 employment deviation would also be
0.17 % because the
deviation in the employment rate would be zero. Recall however that we model
short-run nominal wages as sticky. As such, the 2014 wage does not fully adjust to
its new market clearing level, which accounts for the positive deviation in the 2014
employment rate. The model's wage mechanism requires the deviation in the
nominal wage to grow so long as the deviation in the employment rate is positive.
This accounts for why, in Fig. 16.5 , we see the nominal wage deviation growing up
to 2017, gradually driving the employment rate back towards baseline. Thus, we see
the deviations in employment and the working age population tracking closely
together from 2018 onwards (Fig. 16.5 ).
As discussed in Sect. 16.4.2 , by the end of the simulation period, the deviations
in willingness to pay, risk premium and wage premium have returned to close to
their baseline values (Fig. 16.2 ). Despite this, in Figs. 16.7 and 16.9 , we see that
these behavioral shocks continue to make negative (although tapering)
contributions to the deviations in two key stock variables: population and capital.
The explanation lies in the short—to medium-run impact of these shocks on the
regional capital stock, and the interaction between the capital stock deviation and
the regional population and employment deviations. For example, consider the
investment decomposition (Fig. 16.4 ). Here we see the contribution to the invest-
ment deviation made by the risk premium shock falling to zero by the end of the
simulation period. This reflects the gradual return of the risk premium back to
baseline, as the behavioral effect dissipates. In 2013, the risk premium shock makes
a sizeable contribution to the investment deviation. In 2014, this is manifested as a
negative contribution by the risk premium to the stock of capital (Fig. 16.9 ). In
2014, the risk premium makes a much smaller contribution to the negative invest-
ment deviation (Fig. 16.4 ). Nevertheless, in Fig. 16.9 , the negative contribution of
the risk premium to the capital deviation persists. This is so for two reasons.
First, investment and capital accumulation is modeled as a gradual process: it
takes some years of steady investment to recover from the negative capital devia-
tion generated by the 2013 risk premium shock. Second, the capital deviation and
the employment deviation interact. In 2014 the risk premium shock makes a
negative contribution to the real wage deviation because it lowers the 2014 capital
stock relative to baseline (Fig. 16.9 ), lowering the marginal physical product of
labor. 21 The inter-regional immigration function links year t net immigration to the
year t expected wage, and links year t + 1 population to year t net immigration. Via
these mechanisms, with the risk premium making a negative contribution to the real
21 This accounts for the temporary dip in the real wage deviation in 2014 (See Fig. 16.5 ). A
decomposition diagram of the real wage deviation is available from the authors on request.
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