Working Paper: CEPR ID: DP6800
Authors: Torben M. Andersen; Martin Seneca
Abstract: This paper takes a first step in analysing how a monetary union performs in the presence of labour market asymmetries. Differences in wage flexibility, market power and country sizes are allowed for in a setting with both country-specific and aggregate shocks. The implications of asymmetries for both the overall performance of the monetary union and the country-specific situation are analysed. It is shown that asymmetries are not only critical for country-specific performance but also for the overall performance of the monetary union. A striking finding is that aggregate output volatility is not strictly increasing in nominal rigidities but hump-shaped. Moreover, a disproportionate share of the consequences of wage inflexibility may fall on small countries. In the case of country-specific shocks, a country unambiguously benefits in terms of macroeconomic stability by becoming more flexible, while this is not necessarily the case for aggregate shocks. There may thus be a tension between the degree of flexibility considered optimal at the country level and at the aggregate level within the monetary union.
Keywords: business cycles; monetary policy; monetary union; nominal wage rigidity; shocks; staggered contracts; 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 |
|---|---|
| labour market asymmetries (J42) | macroeconomic stability (E60) |
| aggregate output volatility (E10) | nominal rigidities (D50) |
| nominal rigidities (D50) | output volatility (E23) |
| country-specific shocks (F69) | wage inflexibility (J31) |
| wage inflexibility (J31) | consequences for smaller countries (F55) |
| country-specific shocks (F69) | macroeconomic stability (E60) |
| flexibility in labour markets (J60) | macroeconomic stability (E60) |
| degree of flexibility (Y80) | optimality at country level (O57) |
| degree of flexibility (Y80) | optimality at aggregate level (C61) |