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Asymmetric Labor Market Institutions in the EMU: Positive and Normative Implications

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Abstract

How do asymmetric labor market institutions affect the volatility of inflation and unemployment differentials in a currency union? What are the implications for monetary policy? To answer these questions, this paper sets up a DSGE currency union model with unemployment, hiring frictions and real wage rigidities. The model provides a rigorous but tractable framework for the analysis of the functioning of a currency union characterized by asymmetric labor market institutions. Positively, we find that inflation and unemployment differentials strongly depend on the underlying labor market structures. Moreover, asymmetries in labor market structures increase the volatility of both inflation and unemployment differentials. Normatively, we find that the optimal inflation target should give a higher weight to regions with more sclerotic labor markets but with more flexible real wages.

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File URL: http://repec.graduateinstitute.ch/pdfs/Working_papers/HEIDWP02-2009.pdf
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Bibliographic Info

Paper provided by Economics Section, The Graduate Institute of International Studies in its series IHEID Working Papers with number 02-2009.

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Length: 39
Date of creation: Dec 2007
Date of revision: Apr 2009
Handle: RePEc:gii:giihei:heidwp02-2009

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Keywords: Currency Union; labor market frictions; real wage rigidities; unemployment; sticky prices; inflation differentials; optimal monetary policy.;

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Cited by:
  1. Mirko Abbritti; Sebastian Weber, 2008. "Labor Market Rigidities and the Business Cycle: Price vs. Quantity Restricting Institutions," IHEID Working Papers 01-2008, Economics Section, The Graduate Institute of International Studies, revised Jan 2008.
  2. Abbritti, Mirko & Weber, Sebastian, 2010. "Labor market institutions and the business cycle Unemployment rigidities vs. real wage rigidities," Working Paper Series 1183, European Central Bank.
  3. Spruk, Rok, 2010. "Iceland's Economic and Financial Crisis: Causes, Consequences and Implications," MPRA Paper 29972, University Library of Munich, Germany.

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