Monetary Policy, Country Size and Labour Market Flexibility in the European Monetary Union

Abstract:     
This paper explores the impact of country size on labour market flexibility in a monetary union with a common monetary policy as conducted in EMU. I apply a Barro-Gordon framework and test its result empirically for EMU. Results confirm that small countries demand higher labour market flexibility than large countries. Small countries use labour market flexibility to be protected against monetary policy in favour of large countries and use flexibility as a substitute for monetary policy. Thereby, national inflation volatilities and unemployment volatility are important determinants. Business cycle synchronization reduces the need of small countries for additional labour market flexibility.

Number of Pages in PDF File: 25

Keywords: Structural reforms, labour market flexibility, European Monetary Union, country size, Barro-Gordon model

JEL Classification: D78, E61, F15

working papers series