Labor Market Reform and Monetary Policy in Emu: Do Asymmetries Matter?

Abstract

This Paper analyzes the interaction between a common monetary policy and differentiated labor market institutions. We develop a model of a two country monetary union. In each country, labor market institutions are distinguished by the degree of centralization in wage bargaining. In each country the government can also use an instrument (general taxation or payroll taxes) to influence their overall labor costs. Finally a common monetary policy is followed in a "conservative" manner, as defined by Rogoff (1985). The results show that structural and preference asymmetries matter, both in the determination of economic policy and in performance. In particular centralized labor market institutions confer a certain comparative advantage in policy making which provides a natural incentive for the less flexible (or less reformed) to want to join a currency union; and for the more flexible to stay outside. This lowers the incentives for reform inside the union, as Calmfors and others have conjectured.

Keywords: Monetary union, labor market institutions, asymmetries

JEL Classification: E58, E61, F33, J51