Working Paper: NBER ID: w22489
Authors: Jordi Gal; Tommaso Monacelli
Abstract: We study the gains from increased wage flexibility using a small open economy model with staggered price and wage setting. Two results stand out: (i) the effectiveness of labor cost reductions as a means to stimulate employment is much smaller in a currency union, (ii) an increase in wage flexibility often reduces welfare, more likely so in an economy that is part of a currency union or with 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: wage flexibility; currency union; employment; welfare; monetary policy
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 |
|---|---|
| Labor cost adjustments (J39) | Employment (J68) |
| Labor cost adjustments (J39) | Employment (in a currency union) (F36) |
| Wage flexibility (J31) | Welfare (I38) |
| Wage flexibility (in a currency union) (F36) | Welfare (I38) |
| Wage flexibility (J31) | Price and wage inflation volatility (E31) |
| Price and wage inflation volatility (E31) | Welfare (I38) |