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Asymmetric Labor Market Institutions in the EMU: positive and normative implications

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  • Mirko Abbritti
  • Andreas Mueller

Abstract

How do labor market institutions affect the volatility and persistence of inflation and unemployment in a monetary union? What are the implications for monetary policy? 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 depend strongly on the underlying labor market structure: the hiring friction lowers the persistence and increases the volatility of the inflation differential whereas real wage rigidities imply more persistence and variability in output and unemployment differentials. Normatively, we find that macroeconomic stabilization is easier when labor market frictions are high and real wage rigidities are low. This has important implications for optimal monetary policy: The optimal inflation target should give a higher weight to regions with more sclerotic labor markets and more flexible real wages.

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Bibliographic Info

Paper provided by Department of Economics, Central bank of Iceland in its series Economics with number wp37.

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Date of creation: Dec 2007
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Handle: RePEc:ice:wpaper:wp37

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Cited by:
  1. Abbritti, Mirko & Weber, Sebastian, 2010. "Labor market institutions and the business cycle Unemployment rigidities vs. real wage rigidities," Working Paper Series, European Central Bank 1183, European Central Bank.
  2. Mirko Abbritti; Sebastian Weber, 2008. "Labor Market Rigidities and the Business Cycle: Price vs. Quantity Restricting Institutions," IHEID Working Papers, Economics Section, The Graduate Institute of International Studies 01-2008, Economics Section, The Graduate Institute of International Studies, revised Jan 2008.
  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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