Understanding the Gains from Wage Flexibility: The Exchange Rate Connection

55 Pages Posted: 2 Jun 2014

See all articles by Jordi Galí

Jordi Galí

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Tommaso Monacelli

Bocconi University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: February 2014

Abstract

We study the gains from increased wage flexibility and their dependence on exchange rate policy, using a small open economy model with staggered price and wage setting. Two results stand out: (i) the impact of wage adjustments on employment is smaller the more the central bank seeks to stabilize the exchange rate, and (ii) an increase in wage flexibility often reduces welfare, and more likely in economies under an exchange rate peg or an exchange rate-focused monetary policy. Our findings call into question the common view that wage flexibility is particularly desirable in a currency union.

Keywords: currency unions, exchange rate policy, exchange rate regime, monetary policy rules., New Keynesian model, nominal rigidities, stabilization policies, stabilization policy, sticky wages

JEL Classification: E32, E52, F41

Suggested Citation

Gali, Jordi and Monacelli, Tommaso, Understanding the Gains from Wage Flexibility: The Exchange Rate Connection (February 2014). CEPR Discussion Paper No. DP9806. Available at SSRN: https://ssrn.com/abstract=2444805

Jordi Gali (Contact Author)

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2754 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~gali

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Cambridge, MA 02142
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Tommaso Monacelli

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

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