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Macroeconomic Policy in the Presence of Structural Maladjustment

  • Gordon, Robert J

This paper analyses two-way interactions between structural reform and macroeconomic policy. If structural reforms increase the flexibility of labour markets, they are likely to improve the short-run inflation-unemployment trade-off, providing an incentive for policy-makers to expand aggregate demand. In turn, the promise by policy-makers that they will encourage a decline in unemployment in response to good news on inflation can be used to strike a political deal with political interests opposed to the introduction or extension of structural reform. Expansionary monetary policy also provides relief on the fiscal front, directly, by bringing the actual budget deficit closer to the structural budget deficit, and indirectly, by encouraging structural reform, potentially reducing the structural budget deficit itself. In 1992–3 several European countries dropped out of the ERM to pursue more expansionary monetary policies. The difference in the performance of these countries and those that maintained a peg between their currencies and the Deutsche mark provides an important test case of the consequences of expansionary monetary policy. The depreciating nations by 1995 enjoyed a substantial relative acceleration of nominal GDP and, surprisingly, an even greater deceleration of inflation, so that their growth rate of real GDP accelerated more than their growth rate of nominal GDP in relation to the pegging countries. The continued deceleration of inflation in the depreciating countries provides evidence that their natural unemployment rate has declined and that expansionary monetary policy has interacted beneficially with structural reform.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1493.

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Date of creation: Oct 1996
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Handle: RePEc:cpr:ceprdp:1493
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  1. Bean, Charles R, 1994. "European Unemployment: A Survey," Journal of Economic Literature, American Economic Association, vol. 32(2), pages 573-619, June.
  2. William H. Branson & Julio J. Rotemberg, 1979. "International Adjustment with Wage Rigidity," NBER Working Papers 0406, National Bureau of Economic Research, Inc.
  3. Gordon, Robert J, 1995. "Is There a Trade-off between Unemployment and Productivity Growth?," CEPR Discussion Papers 1159, C.E.P.R. Discussion Papers.
  4. Rod Cross, 2000. "Hysteresis and Emu," Metroeconomica, Wiley Blackwell, vol. 51(4), pages 367-379, November.
  5. De Grauwe, Paul, 1995. "The Economics of Convergence towards Monetary Union in Europe," CEPR Discussion Papers 1213, C.E.P.R. Discussion Papers.
  6. Jeffrey D. Sachs, 1979. "Wages, Profits, and Macroeconomic Adjustment: A Comparative Study," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 10(2), pages 269-332.
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