The Shocks Matter: Labor Mobility and the Welfare Cost of a Currency Union
42 Pages Posted: 22 Aug 2022 Last revised: 16 Sep 2022
Date Written: September 07, 2024
Abstract
In this paper, we study the impact of labor mobility on the welfare cost of currency union in an open economy New Keynesian model. We find that the relationship between labor mobility and exchange rate flexibility depends on the source of asymmetric regional shocks. With demand shocks, labor mobility substitutes for flexible exchange rates regime since it will minimize the costs of asymmetric demand levels across regions. With supply shocks, flexible exchange rates can work in conjunction with highly mobile labor to reallocate the factors of production to higher productivity regions of potential currency areas. Thus, exchange rate flexibility and labor mobility can be complements instead of substitutes and areas with high inter-regional labor mobility may benefit most from exchange rate flexibility.
Keywords: Labor Mobility, Welfare, Exchange Rate Regime
JEL Classification: F3, F4
Suggested Citation: Suggested Citation