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Wage divergence, business cylce co-movement and the currency union effect

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  • Gächter, Martin

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  • Gruber, Alexander

    ()

  • Riedl, Aleksandra

    ()

Abstract

The European debt crisis reminded us that some member countries of Economic and Monetary Union (EMU) experienced unsustainable pre-crisis booms accompanied by an increase in wages far beyond what would have been justified by long-lasting trends in labor productivity. Within a currency union, such diverging trends in wages and competitiveness cannot be mitigated by simply adjusting nominal exchange rates. Against this background, it is astonishing that the impact of labor cost dynamics on business cycle co-movement – the most widely used meta-criterion for an optimum currency area – has not been analyzed so far. In our empirical analysis, we reveal a highly significant and policy-relevant finding: While wage developments do not affect business cycle convergence outside a currency union, wage growth differentials across countries significantly reduce business cycle co-movement within a common currency area. The economic significance of the effect is surprisingly large and even exceeds the impact of bilateral trade relations.

Suggested Citation

  • Gächter, Martin & Gruber, Alexander & Riedl, Aleksandra, 2016. "Wage divergence, business cylce co-movement and the currency union effect," Economics Working Paper Series 1605, University of St. Gallen, School of Economics and Political Science.
  • Handle: RePEc:usg:econwp:2016:05
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    References listed on IDEAS

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    Cited by:

    1. repec:eee:jpolmo:v:40:y:2018:i:2:p:284-304 is not listed on IDEAS
    2. Elizaveta Lukmanova & Gabriele Tondl, 2016. "Macroeconomic Imbalances and Business Cycle Synchronization. Why Common Economic Governance is Imperative for the Eurozone," Department of Economics Working Papers wuwp229, Vienna University of Economics and Business, Department of Economics.
    3. Loewald, Christopher & Wörgötter, Andreas, 2019. "Do monetary unions dream of structural reforms?," ECON WPS - Vienna University of Technology Working Papers in Economic Theory and Policy 01/2019, Vienna University of Technology, Institute for Mathematical Methods in Economics, Research Group Economics (ECON).
    4. repec:kap:atlecj:v:47:y:2019:i:2:d:10.1007_s11293-019-09618-5 is not listed on IDEAS
    5. Lukmanova, Elizaveta & Tondl, Gabriele, 2016. "Macroeconomic Imbalances and Business Cycle Synchronization. Why Common Economic Governance is Imperative for the Eurozone," Department of Economics Working Paper Series 229, WU Vienna University of Economics and Business.
    6. repec:eee:jmacro:v:55:y:2018:i:c:p:12-27 is not listed on IDEAS
    7. repec:dat:earchi:y:2019:i:1:p:19-32 is not listed on IDEAS

    More about this item

    Keywords

    Business Cycle Synchronization; Unit Labor Costs; Competitiveness; Currency Union; Optimum Currency Area;

    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
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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