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This article investigates the effect of product market liberalisation on employment allowing for interactions between policies and institutions in product and labour markets. Using panel data for OECD countries over the period 1980-2002, we present evidence that product market deregulation is more effective at the margin when labour market regulation is high. The data also suggest that product market liberalisation may promote employment-enhancing labour market reforms.Over the past two decades, many OECD countries have sought to promote productivity and long-term growth by improving the efficiency of goods and services markets through liberalisation and privatisation programmes. There is a growing body of evidence suggesting that these programmes have indeed boosted productivity performances in the sectors concerned, 1 but there is less evidence on their impacts on employment. A few recent theoretical and empirical studies suggest that product market deregulation may stimulate aggregate employment, yet firm conclusions are still lacking.2 In assessing the effect of product market regulatory reforms, it is crucial to take into account that these reforms have been implemented in countries with very different labour market settings. This raises two related questions. First, do the employment gains from product market deregulation depend upon the underlying labour market policies and institutions that shape the bargaining power of workers and, if so, how? Second, do reforms that promote stronger product market competition lead to changes in labour market policies and institutions?The employment effect of interactions between product and labour market policies is still an open issue.3 Empirical analyses of interaction effects have typically not been based on predictions of fully specified theoretical models, the estimated employment

This paper explores the effects of labor and product market reforms in a New Keynesian, small open economy model with labor market frictions and endogenous producer entry. We show that it takes time for reforms to pay off, typically at least a couple of years. This is partly because the benefits materialize through firm entry and increased hiring, both of which are gradual processes, while any reform-driven layoffs are immediate. Some reforms-such as reductions in employment protection-increase unemployment temporarily. Implementing a broad package of labor and product market reforms minimizes transition costs. Importantly, reforms do not have noticeable deflationary effects, suggesting that the inability of monetary policy to deliver large interest rate cuts in their aftermath-either because of the zero bound on policy rates or because of membership in a monetary union-may not be a relevant obstacle to reform. Alternative simple monetary policy rules do not have a large effect on transition costs.

We study the consequences of product and labor market reforms in a two-country model with endogenous producer entry and labor market frictions. We focus on the role of business cycle conditions and external constraints at the time of reform implementation (or of a credible commitment to it) in shaping the dynamic effects of such policies. Product market reform is modeled as a reduction in entry costs and takes place in a non-traded sector that produces services used as input in manufacturing production. Labor market reform is modeled as a reduction in firing costs and/or unemployment benefits. We find that business cycle conditions at the time of deregulation significantly affect adjustment. A reduction of firing costs entails larger and more persistent adverse short-run effects on employment and output when implemented in a recession. By contrast, a reduction in unemployment benefits boosts employment and output by more in a recession compared to normal times. The impact of product market reforms is less sensitive to business cycle conditions. Credible announcements about future reforms induce sizable short-run dynamics, regardless of whether the announcement takes place in normal times or during an economic downturn. Whether the immediate effect is expansionary or contractionary varies across reforms. Finally, lack of access to international lending in the wake of reform can amplify the costs of adjustment.

The wave of crises that began in 2008 reheated the debate on market deregulation as a tool to improve economic performance. This paper addresses the consequences of increased flexibility in goods and labor markets for the conduct of monetary policy in a monetary union. We model a two-country monetary union with endogenous product creation, labor market frictions, and price and wage rigidities. Regulation affects producer entry costs, employment protection, and unemployment benefits. We first characterize optimal monetary policy when regulation is high in both countries and show that the Ramsey allocation requires significant departures from price stability both in the long run and over the business cycle. Welfare gains from the Ramsey-optimal policy are sizable. Second, we show that the adjustment to market reform requires expansionary policy to reduce transition costs. Third, deregulation reduces static and dynamic inefficiencies, making price stability more desirable. International synchronization of reforms can eliminate policy tradeoffs generated by asymmetric deregulation.