Working Paper: CEPR ID: DP8010
Authors: Pietro Biroli; Gilles Mourre; Alessandro Antonio Turrini
Abstract: This paper analyses the adjustment mechanism in the euro area. Results show that the real exchange rate (REER) adjusts in such a way to redress cyclical divergences and that after monetary unification REER dynamics have become less reactive to country-specific shocks but also less persistent. It is found that regulations, notably affecting price and wage nominal flexibility and employment protection, play a role in the adjustment mechanism. Indicators of product and labour regulations appear to matter for both the reaction of price competitiveness to cyclical divergences (differences between national and euro-area output gaps) and for the inertia of competitiveness indicators. Moreover, regulations appear to matter also for the extent to which common shocks may have country-specific effects on price competitiveness, as revealed by their interaction with proxies of unobservable common shocks รก-la Blanchard and Wolfers (2000). In light of the tendency towards less stringent regulations in past decades, the results seem consistent with the observed reduction in the persistence of inflation differentials, and have implications for the design of adjustment-friendly product and labour market reforms.
Keywords: competitiveness; euro area; adjustment; labour and product market institutions; monetary unification; nominal flexibility; regulations
JEL Codes: E30; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Regulations affecting price and wage nominal flexibility and employment protection (E64) | Adjustment mechanism in the euro area (E52) |
| Real exchange rate (REER) (F31) | Differences between domestic and euro area average output gaps (P24) |
| Differences in regulations across euro area countries (F36) | Varying effects of common shocks on price competitiveness (F69) |
| Less stringent regulations (K29) | Reductions in inflation differentials' persistence (E31) |
| Regulations (L51) | Adjustment to idiosyncratic shocks (D89) |