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When is labour market flexibility welcome? More on asymmetric policy impacts in Europe

  • S. Sgherri

This paper provides further model-based evidence about the effects of engaging in an Economic and Monetary Union (EMU) when monetary transmission mechanisms differ across countries. Sensitivity analysis to alternative monetary regimes shows that with EMU, where exchange-rate fluctuations are internalised and monetary co-operation enforced, the overall sensitivity to symmetric monetary shocks is likely to be weaker than under different arrangements. This may render cross-country asymmetries in policy responses less evident, at least with respect to the core European economies. Conversely, for countries characterised by higher flexibility, EMU seems to induce policy overreaction compared with uncoordinated monetary stances. In this way, it could widen the gap between rigid and flexible economies. Although different degrees of rigidity in country-specific inflation-output relationships are found sufficient to undermine synchronisation in their business cycle under EMU, labour market discipline is not able to ensure convergence on its own. In particular, responsiveness to monetary changes is to be greater, ceteris paribus, in high-debt countries. On this basis, the paper argues that increased nominal and real flexibility in these labour markets would only trigger further cyclicity in the face of common monetary shocks. This seems to suggest a clear ordering in the sequence of structural reforms these countries need to undertake.

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Paper provided by Netherlands Central Bank, Research Department in its series WO Research Memoranda (discontinued) with number 619.

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Date of creation: 2000
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Handle: RePEc:dnb:wormem:619
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