Working Paper: CEPR ID: DP9806
Authors: Jordi Gal; Tommaso Monacelli
Abstract: We study the gains from increased wage flexibility and their dependence on exchange rate policy, using a small open economy model with staggered price and wage setting. Two results stand out: (i) the impact of wage adjustments on employment is smaller the more the central bank seeks to stabilize the exchange rate, and (ii) an increase in wage flexibility often reduces welfare, and more likely in economies under an exchange rate peg or an exchange rate-focused monetary policy. Our findings call into question the common view that wage flexibility is particularly desirable in a currency union.
Keywords: currency unions; exchange rate policy; exchange rate regime; monetary policy rules; new keynesian model; nominal rigidities; stabilization policies; sticky wages
JEL Codes: E32; E52; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Wage flexibility (J31) | Employment effectiveness (J68) |
| Central bank prioritizing exchange rate stabilization (E52) | Wage flexibility effectiveness (J33) |
| Wage flexibility (J31) | Welfare (I38) |
| Exchange rate policies (F31) | Welfare (I38) |