Wage Divergence, Business Cycle Co‐Movement and the Currency Union Effect

21 Pages Posted: 25 Oct 2017

See all articles by Martin Gächter

Martin Gächter

University of Innsbruck - Department of Economics & Statistics; Oesterreichische Nationalbank (OeNB), Foreign Research Division

Alexander Gruber

University of St. Gallen

Aleksandra Riedl

Oesterreichische Nationalbank (OeNB), Foreign Research Division

Date Written: November 2017

Abstract

This paper studies the impact of wage growth divergence on business cycle co‐movement in the context of currency unions. While the theoretical literature on optimum currency areas highlights the equilibrating effect of divergent wage growth after asymmetric exogenous demand shocks via the external demand channel, recent literature on euro area imbalances emphasizes its dis‐equilibrating effect as a source of asymmetric domestic demand shocks, and therefore suggests a negative link to business cycle co‐movement. Our empirical results reveal that the latter effect has been clearly dominating in the euro area: Wage growth differentials across countries – while of minor importance for non‐euro area EU countries with sovereign currencies – significantly reduce business cycle co‐movement within the monetary union and thus increase the cost of the common monetary policy. The large magnitude of the effect calls for enhanced co‐ordination efforts of wage policies in the euro area.

Keywords: business cycle synchronization, wages, unit labour costs, competitiveness, currency union, optimum currency area

Suggested Citation

Gächter, Martin and Gruber, Alexander and Riedl, Aleksandra, Wage Divergence, Business Cycle Co‐Movement and the Currency Union Effect (November 2017). JCMS: Journal of Common Market Studies, Vol. 55, Issue 6, pp. 1322-1342, 2017. Available at SSRN: https://ssrn.com/abstract=3058432 or http://dx.doi.org/10.1111/jcms.12574

Martin Gächter (Contact Author)

University of Innsbruck - Department of Economics & Statistics ( email )

Universitaetsstrasse 15/4
Innsbruck, 6020
Austria
+43 512 507 7164 (Phone)

HOME PAGE: http://www.uibk.ac.at

Oesterreichische Nationalbank (OeNB), Foreign Research Division ( email )

Otto-Wagner-Platz 3
1090 Vienna
Austria

Alexander Gruber

University of St. Gallen

Aleksandra Riedl

Oesterreichische Nationalbank (OeNB), Foreign Research Division ( email )

Otto-Wagner-Platz 3
1090 Vienna
Austria

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