Working Paper: CEPR ID: DP9742
Authors: Matteo Cacciatore; Giuseppe Fiori; Fabio Ghironi
Abstract: The wave of crises that began in 2008 reheated the debate on market deregulation as a tool to improve economic performance. This paper addresses the consequences of increased flexibility in goods and labor markets for the conduct of monetary policy in a monetary union. We model a two-country monetary union with endogenous product creation, labor market frictions, and price and wage rigidities. Regulation affects producer entry costs, employment protection, and unemployment benefits. We first characterize optimal monetary policy when regulation is high in both countries and show that the Ramsey allocation requires significant departures from price stability both in the long run and over the business cycle. Welfare gains from the Ramsey-optimal policy are sizable. Second, we show that the adjustment to market reform requires expansionary policy to reduce transition costs. Third, deregulation reduces static and dynamic inefficiencies, making price stability more desirable. International synchronization of reforms can eliminate policy tradeoffs generated by asymmetric deregulation.
Keywords: market deregulation; monetary union; optimal monetary policy
JEL Codes: E24; E32; E52; F41; J64; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high regulation (K20) | positive long-run inflation target of 1-2 percent (E31) |
| Ramsey-optimal policy (H21) | increase welfare by approximately 0.5 percent of annual steady-state consumption (D69) |
| deregulation (L51) | need for aggressive monetary policy responses (E63) |
| deregulation (L51) | improved economic conditions that favor price stability (E64) |
| international synchronization of reforms (F30) | enhance welfare outcomes across countries (D60) |