Working Paper: CEPR ID: DP4430
Authors: torben m andersen
Abstract: How does a monetary union work when labour markets are heterogeneous? Since shocks are transmitted via both trade links and the common monetary policy and propagated via labour market responses, it follows that labour market institutions may have not only national but also union-wide implications. These issues are analysed in an intertemporal general equilibrium model for a currency union in which labour markets are heterogenous and where the monetary policy targets expected inflation. More flexibility in adjustment means more stable aggregate output, but inflation control becomes more difficult. Heterogeneity in adjustment plays a large role, in particular if country sizes are also asymmetric. This also holds in the case of aggregate shocks both for the variability of aggregate output and inflation. Considering the effects on country specific output variability it is seen that there are important spillover effects between labour market structures, and that it is not necessarily beneficial to make a unilateral move to make labour markets more flexible.
Keywords: business cycles; monetary policy; monetary union; shocks; wage formation
JEL Codes: e30; e52; f41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| labor market flexibility (J48) | aggregate output stability (E23) |
| labor market flexibility (J48) | inflation control (E64) |
| heterogeneous labor markets (J49) | transmission of economic shocks (F42) |
| rigid labor markets in one country (F16) | negative impact on flexible labor markets in others (F66) |
| wage flexibility (J31) | economic stability (E63) |