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Macroeconomic Volatilities and the Labor Market: First Results from the Euro Experiment

  • Christian Merkl
  • Tom Schmitz

This paper analyzes the effects of different labor market institutions on inflation and output volatility. The eurozone offers an unprecedented experiment for this exercise: since 1999, no national monetary policies have been implemented that could account for volatility differences across member states, but labor market characteristics have remained very diverse. We use a New Keynesian model with unemployment to predict the effects of different labor market institutions on macroeconomic volatilities. In our subsequent empirical estimations, we find that higher labor turnover costs have a statistically significant negative effect on output volatility, while replacement rates have a positive effect, both of which are in line with theory. Real wage rigidities do not seem to play much of a role. This result is in line with our employed labor market model, but stands in stark contrast to the search and matching model. While labor market institutions have a large effect on output volatility, they do not seem to have much of an effect on inflation volatility. Our estimations indicate that the latter is driven instead to a certain extent by differences in government spending volatility

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Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1511.

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Length: 24 pages
Date of creation: Apr 2009
Date of revision:
Handle: RePEc:kie:kieliw:1511
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