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Wage Divergence, Business Cycle Co-Movement and the Currency Union Effect

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  • Martin Gächter
  • Alexander Gruber
  • Aleksandra Riedl

Abstract

The European debt crisis reminded us that some member countries of Economic and Monetary Union (EMU) experienced unsustainable pre-crisis booms accompanied by an increase in wages far beyond what would have been justified by long-lasting trends in labor productivity. Within a currency union, such diverging trends in wages and competitiveness cannot be mitigated by simply adjusting nominal exchange rates. Against this background, it is astonishing that the impact of labor cost dynamics on business cycle co-movement – the most widely used meta-criterion for an optimum currency area – has not been analyzed so far. In our empirical analysis, we reveal a highly significant and policy-relevant finding: While wage developments do not affect business cycle convergence outside a currency union, wage growth differentials across countries significantly reduce business cycle co-movement within a common currency area. The economic significance of the effect is surprisingly large and even exceeds the impact of bilateral trade relations.
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  • Martin Gächter & Alexander Gruber & Aleksandra Riedl, 2017. "Wage Divergence, Business Cycle Co-Movement and the Currency Union Effect," Journal of Common Market Studies, Wiley Blackwell, vol. 55(6), pages 1322-1342, November.
    • Handle: RePEc:bla:jcmkts:v:55:y:2017:i:6:p:1322-1342
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    File URL: http://hdl.handle.net/10.1111/jcms.12574
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    Cited by:

    1. Ramskogler, Paul, 2021. "Labour market hierarchies and the macro-economy – Do labour market dualities affect wage growth in Europe?," Structural Change and Economic Dynamics, Elsevier, vol. 56(C), pages 154-165.
    2. Rémi Odry & Roman Mestre, 2021. "Monetary Policy and Business Cycle Synchronization in Europe," EconomiX Working Papers 2021-19, University of Paris Nanterre, EconomiX.
    3. Nestor Azcona, 2019. "Specialization and Business Cycle Co-Movement in the Euro Area," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 47(2), pages 193-204, June.
    4. Sabrina Bunyan & David Duffy & George Filis & Ishmael Tingbani, 2020. "Fiscal policy, government size and EMU business cycle synchronization," Scottish Journal of Political Economy, Scottish Economic Society, vol. 67(2), pages 201-222, May.
    5. Lukmanova, Elizaveta & Tondl, Gabriele, 2017. "Macroeconomic imbalances and business cycle synchronization. Why common economic governance is imperative for the Eurozone," Economic Modelling, Elsevier, vol. 62(C), pages 130-144.
    6. Sabrina Bunyan & David Duffy & George Filis & Ishmael Tingbani, 2018. "Bilateral business cycle synchronisation in the EMU: What is the role of fiscal policy and government size?," Working Papers 2018.02, International Network for Economic Research - INFER.
    7. Ahlborn, Markus & Wortmann, Marcus, 2018. "The core‒periphery pattern of European business cycles: A fuzzy clustering approach," Journal of Macroeconomics, Elsevier, vol. 55(C), pages 12-27.
    8. Gächter, Martin & Ramskogler, Paul & Riedl, Aleksandra, 2018. "The trinity of wage setting in EMU: A policy proposal," Journal of Policy Modeling, Elsevier, vol. 40(2), pages 284-304.
    9. Horatiu DAN, 2019. "Joining The Euro Zone – An Exploration Of Real And Structural Convergence In Romania, Bulgaria And Croatia," Economic Archive, D. A. Tsenov Academy of Economics, Svishtov, Bulgaria, issue 1 Year 20, pages 19-32.
    10. Loewald, Christopher & Wörgötter, Andreas, 2019. "Do monetary unions dream of structural reforms?," ECON WPS - Working Papers in Economic Theory and Policy 01/2019, TU Wien, Institute of Statistics and Mathematical Methods in Economics, Economics Research Unit.

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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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