Welfare Implications of Heterogeneous Labor Markets in a Currency Area

42 Pages Posted: 22 Sep 2010

See all articles by Céline Poilly

Céline Poilly

Banque de France

Jean-Guillaume Sahuc

Banque de France; Université Paris Ouest - Nanterre, La Défense - EconomiX

Date Written: February 2008

Abstract

This paper investigates the role of labor markets heterogeneity in a monetary union and especially what are the welfare gains/costs of labor market reforms for each member of the area. To this end, we develop a medium-scale two-country model representing a currency union characterized by price and wage stickiness, real rigidities and labor market frictions. We make various scenarios of labor market reform and seek to determine the direction in which a country has an incentive to direct it from a welfare perspective. We find that the choice of the instrument to direct a reform (aiming at reducing the home unemployment rate) has drastic welfare implications in the union. Reforming the domestic labor market by a stronger regulation seems to give the best output. The analysis also shows that labor markets heterogeneity has sizeable effects on the amount of welfare gains, following a reform. The more flexible the foreign labor market, the higher its welfare. Finally, a sensitivity analysis shows that (i) the way the monetary authorities conduct their policy has negligible welfare effects but (ii) the size of a country in the monetary union is far to be neutral.

Keywords: DSGE model, currency union, heterogeneity, matching frictions, welfare

JEL Classification: C3, C5

Suggested Citation

Poilly, Céline and Sahuc, Jean-Guillaume, Welfare Implications of Heterogeneous Labor Markets in a Currency Area (February 2008). Banque de France Working Paper No. 199, Available at SSRN: https://ssrn.com/abstract=1680229 or http://dx.doi.org/10.2139/ssrn.1680229

Céline Poilly (Contact Author)

Banque de France ( email )

Paris
France

Jean-Guillaume Sahuc

Banque de France ( email )

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France
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Université Paris Ouest - Nanterre, La Défense - EconomiX ( email )

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