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Welfare Implications of Heterogeneous Labor Markets in a Currency Area

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Author Info
Poilly, C.
Sahuc, J-G.

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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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Publisher Info
Paper provided by Banque de France in its series Documents de Travail with number 199.

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

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Related research
Keywords: DSGE model ; Currency union ; Heterogeneity ; Matching frictions ; Welfare.;

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Find related papers by JEL classification:
C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
C5 - Mathematical and Quantitative Methods - - Econometric Modeling

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