This paper explores the short-term effects of labour and product market reforms through a dynamic
general equilibrium model that features endogenous producer entry, equilibrium unemployment and costly
job creation and destruction. Unlike in existing work, the link between labour and product market
dynamics and the policy factors driving it are modelled explicitly. The analysis yields three main findings.
First, it takes time for reforms to pay off, typically at least a couple of years. This is partly because their
benefits materialise through firm entry and increased hiring, both of which are gradual processes, while
any reform-driven layoffs are immediate. Second, all reforms appear to stimulate GDP already in the short
run, but some of them -- such as job protection reforms -- are found to increase unemployment temporarily.
Implementing a broad package of labour and product market reforms enables governments to minimise or
even alleviate such transitional costs. Third, reforms are not found to have noticeable deflationary effects,
suggesting that the inability of monetary policy to deliver large interest rate cuts in their aftermath -- either
because of the zero bound on policy rates or because the country belongs to a large monetary union -- may
not be a relevant obstacle to reform implementation. Alternative simple monetary policy rules have little
impact on the transitional costs from reforms.
