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Labor market reform and price stability: an application to the Euro Area

  • Carlos Thomas

    ()

    (Banco de España)

  • Francesco Zanetti

    ()

    (Bank of England)

This paper studies the effect of labor market reform, in the form of reductions in firing costs and unemployment benefits, on inflation volatility. With this purpose, we build a New Keynesian model with search and matching frictions in the labor market, and estimate it using Euro Area data. Qualitatively, changes in labor market policies alter the volatility of inflation in response to shocks, by affecting the volatility of the three components of real marginal costs (hiring costs, firing costs and wage costs). Quantitatively, we find however that neither policy is likely to have an important effect on inflation volatility, due to the small impact of changes in the volatility of the labor market on inflation dynamics.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/08/Fic/dt0818e.pdf
File Function: First version, September 2008
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0818.

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Length: 37 pages
Date of creation: Sep 2008
Date of revision:
Handle: RePEc:bde:wpaper:0818
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  18. Thomas Lubik & Michael Krause, 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Economics Working Paper Archive 504, The Johns Hopkins University,Department of Economics.
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