Journal
JOURNAL OF ECONOMIC DYNAMICS & CONTROL
Volume 35, Issue 5, Pages 793-812Publisher
ELSEVIER
DOI: 10.1016/j.jedc.2010.07.001
Keywords
Inflation volatility; Labor market institutions; EMU
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Despite having had the same currency for many years, EMU countries still have quite different inflation dynamics. In this paper we explore one possible reason: country specific labor market institutions, giving rise to different inflation volatilities. When unemployment insurance schemes differ, as they do in EMU, reservation wages react differently in each country to area-wide shocks. This implies that real marginal costs and inflation also react differently. We report evidence for EMU countries supporting the existence of a cross-country link over the cycle between labor market structures on the one side and real wages and inflation on the other. We then build a DSGE model that replicates the data evidence. The inflation volatility differentials produced by asymmetric labor markets generate welfare losses at the currency area level of approximately 0.3% of steady state consumption. (C) 2010 Elsevier B.V. All rights reserved.
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