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

Author

Listed:
  • Carlos Thomas

    (Banco de España)

  • Francesco Zanetti

    (Bank of England)

Abstract

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.

Suggested Citation

  • Carlos Thomas & Francesco Zanetti, 2008. "Labor market reform and price stability: an application to the Euro Area," Working Papers 0818, Banco de España.
    • Handle: RePEc:bde:wpaper:0818
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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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