Working Paper: CEPR ID: DP18225
Authors: Harald Fadinger; Philipp Herkenhoff; Jan Schymik
Abstract: We examine the effects of unilateral structural reforms within a currency union. Focusing on the surge of German competitiveness following the introduction of the Euro, we first provide reduced-form causal evidence supporting the notion that German structural labor-market reforms in the early 2000s led to a crowding-out of manufacturing employment in other Eurozone economies. To assess the impact of this German competitiveness shock, we build a quantitative multi-sector trade model that features downward nominal wage rigidities, endogenous labor supply, unemployment-insurance benefits and international savings. The fixed nominal exchange rate can create binding nominal rigidities in response to a foreign real supply shock -- like the one prompted by the German reforms -- resulting in significant contraction of manufacturing sectors and increased involuntary unemployment across other Eurozone countries. We consider a number of counterfactual scenarios, such as the impact of German labor-market reforms in the absence of a fixed exchange-rate regime, the role of coordinated reforms within the Eurozone and a higher average inflation rate.
Keywords: euro; quantitative trade models; nominal rigidities; labor markets; structural reforms; import competition; spillovers
JEL Codes: F16; F41; F45
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| decline in real wages in Germany (N14) | real depreciation of German goods relative to those of other eurozone economies (F69) |
| nominal wages in other eurozone countries did not adjust downward (J39) | involuntary unemployment and significant contractions in manufacturing sectors (F66) |
| German labor market reforms in the early 2000s (J48) | increase in German competitiveness (F69) |
| increase in German competitiveness (F69) | crowding out of manufacturing employment in other eurozone countries (F66) |
| one percentage point increase in German export-market competition (F69) | approximately a 0.9 log-point reduction in manufacturing employment in other eurozone economies (F69) |
| German competitiveness shock (N14) | significant contractions in manufacturing sectors in other eurozone countries (F44) |
| German competitiveness shock (N14) | increased involuntary unemployment in other eurozone countries (J69) |