Understanding the Gains from Wage Flexibility: The Exchange Rate Connection

38 Pages Posted: 8 Aug 2016

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: August 2016

Abstract

We study the gains from increased wage flexibility using a small open economy model with staggered price and wage setting. Two results stand out: (i) the effectiveness of labor cost reductions as a means to stimulate employment is much smaller in a currency union, (ii) an increase in wage flexibility often reduces welfare, more likely so in an economy that is part of a currency union or with an exchange rate-focused monetary policy. Our findings call into question the common view that wage flexibility is particularly desirable in a currency union.

Suggested Citation

Gali, Jordi and Monacelli, Tommaso, Understanding the Gains from Wage Flexibility: The Exchange Rate Connection (August 2016). NBER Working Paper No. w22489. Available at SSRN: https://ssrn.com/abstract=2819894

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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