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Welfare Implications of Heterogeneous Labor Markets in a Currency Area

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  • Poilly, C.
  • Sahuc, J-G.

Abstract

This paper investigates the role of labor markets heterogeneity in a monetary union and especially what are the welfare gains/costs of labor market reforms for each member of the area. To this end, we develop a medium-scale two-country model representing a currency union characterized by price and wage stickiness, real rigidities and labor market frictions. We make various scenarios of labor market reform and seek to determine the direction in which a country has an incentive to direct it from a welfare perspective. We find that the choice of the instrument to direct a reform (aiming at reducing the home unemployment rate) has drastic welfare implications in the union. Reforming the domestic labor market by a stronger regulation seems to give the best output. The analysis also shows that labor markets heterogeneity has sizeable effects on the amount of welfare gains, following a reform. The more flexible the foreign labor market, the higher its welfare. Finally, a sensitivity analysis shows that (i) the way the monetary authorities conduct their policy has negligible welfare effects but (ii) the size of a country in the monetary union is far to be neutral.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 199.

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Length: 37 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:bfr:banfra:199

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Web page: http://www.banque-france.fr/
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Keywords: DSGE model ; Currency union ; Heterogeneity ; Matching frictions ; Welfare.;

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References

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Cited by:
  1. Abbritti, Mirko & Mueller, Andreas I., 2012. "Asymmetric Labor Market Institutions in the EMU and the Volatility of Inflation and Unemployment Differentials," IZA Discussion Papers 6488, Institute for the Study of Labor (IZA).
  2. Dennis Wesselbaum, 2010. "Price Bargaining, the Persistence Puzzle, and Monetary Policy," Kiel Working Papers 1629, Kiel Institute for the World Economy.
  3. Wesselbaum, Dennis, 2009. "Firing Tax vs. Severance Payment - An Unequal Comparison," MPRA Paper 17637, University Library of Munich, Germany.
  4. Raquel FONSECA & Lise PATUREAU & Thepthida SOPRASEUTH, 2009. "Divergence in Labor Market Institutions and International Business Cycles," Annales d'Economie et de Statistique, ENSAE, issue 95-96, pages 279-314.
  5. Poilly, Céline & Wesselbaum, Dennis, 2014. "Evaluating labor market reforms: A normative analysis," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 156-170.
  6. Dennis Wesselbaum, 2009. "Firing Costs in a New Keynesian Model with Endogenous Separations," Kiel Working Papers 1550, Kiel Institute for the World Economy.
  7. Björn van Roye & Dennis Wesselbaum, 2009. "Capital, Endogenous Separations, and the Business Cycle," Kiel Working Papers 1561, Kiel Institute for the World Economy.

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