Working Paper: CEPR ID: DP2217
Authors: Michael C. Burda
Abstract: Widespread concern over real effects of EMU is consistent with new Keynesian approaches to macroeconomic fluctuations, but more difficult to reconcile with a real business cycle (RBC) paradigm. Using a model with frictions as a point of departure, I speculate that nominal price rigidity in Europe is likely to increase, while real rigidities are likely to decrease, as a consequence of monetary union. This logic implies a new European macroeconomic regime in which monetary policy is increasingly 'effective' in influencing output in the short run. Similarly, changes in the nature of real and nominal price determination are likely to increase the volatility of the European business cycle. Empirical evidence of increasing covariation of price inflation and declining correlation of wage inflation and real wage growth within EMU countries in the last decade is consistent with this conjecture. Calls for additional labour market flexibility, given the magnitude of what is already in store for Europe, may be unwarranted.
Keywords: euro; european integration; european monetary union; monetary transmission mechanism
JEL Codes: E52; J51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| introduction of a common currency (F36) | increase nominal price rigidity (E31) |
| increase nominal price rigidity (E31) | decrease incentive to adjust prices (L11) |
| increase product market integration and competition (F15) | decrease real rigidities in labor markets (J48) |
| decrease real rigidities in labor markets (J48) | increase flexibility in labor market (J69) |
| EMU (F36) | changes in macroeconomic regime (E65) |
| changes in macroeconomic regime (E65) | increase potency of monetary policy (E52) |