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Welfare Implications Of Heterogeneous Labor Markets In A Currency Area

  • Poilly, Céline
  • Sahuc, Jean-Guillaume

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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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 17 (2013)
Issue (Month): 02 (March)
Pages: 294-325

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Handle: RePEc:cup:macdyn:v:17:y:2013:i:02:p:294-325_00
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