Heterogeneity, Rigidity and Convergence of Labor Markets in the Euro Area

This paper investigates the welfare consequences of labor-market convergence reforms for a large range of calibrations in a two-country monetary-union DSGE model with search and matching frictions. The model features trade in consumption and investment goods, price stickiness, firing costs and is calibrated to reflect the structural asymmetries of flexible and rigid countries of the Euro Area in terms of size and labor-market variables. Across steady states, convergence brings welfare gains for the rigid country and welfare losses for the flexible country in most situations studied. The higher the flexibility induced by the convergence, the higher the welfare gains. Taking into account the transition path does not strongly modify the insights of the steady-state analysis. However, the number of situations in which both countries experience long-term welfare gains is higher than in the steady-state analysis. In the short run, the rigid country experiences welfare gains and the flexible country welfare losses whatever the situation. As such, I conclude that a convergence of the labor markets can lead to substantial welfare gains in a monetary union, especially if the implementation is carefully designed.