German Wage Moderation and European Imbalances: Feeding the Global VAR with Theory

Abstract

Reproduction permitted only if source is stated. ISBN 978-3-95729-156-1 (Internetversion) Non-technical summary Research QuestionIt is widely acknowledged that internal current account imbalances in Europe were an important factor behind the financial distress experienced by countries in the Eurozone. What is more controversial, however, is what the main drivers of these imbalances were. Several institutions mention the increase in German competitiveness since the late 1990s as an important determinant of these imbalances driven by German labor market reforms. Particularly, the decline in German real wages, relative to the Euro Area partners, is cited as a key factor. The decline in real wages can mainly be attributed to a shift from collective bargaining to concession bargaining and the introduction of opening clauses in employment contracts. We test the contribution of shocks to the German labor market, in the form of a reduction in workers' wage bargaining power, to Eurozone current account imbalances. ContributionPrevious work employed mainly Dynamic Stochastic General Equilibrium (DSGE) models with two or three countries to investigate the importance of German labor market reforms. We, however, make use of a Global Vector Autoregressive (GVAR) model for 9 Euro Area countries in order to measure the spillover effects of wage bargaining power shocks using a sample of 62 observations ranging from 1992Q1 to 2007Q2. Identification of these shocks in Germany is achieved by deriving minimal robust sign restrictions from a small open economy New Keynesian DSGE model with search and matching frictions. The use of a structural GVAR is advantageous because it achieves identification from theory but allows the responses of variables to shocks to be data-determined for the most part, avoiding the reliance on overly restrictive structural models. This allows us to assess whether the role of spillovers from German labor market reforms is quantitatively important. ResultsWe show that negative shocks to bargaining power in Germany do generally cause an improvement of the domestic current account, while foreign responses are heterogeneous. However, they account only for a very small fraction of the current account balance forecast error variances. Counterfactual analysis shows that the effect of these shocks on the increasing dispersion of the Eurozone current accounts before the crisis is essentially negligible. Hence, German wage moderation cannot be the lone driver of European imbalances. Nichttechnische Zusammenfassung AbstractGerman labor market reforms in the 1990s and 2000s are generally believed to have driven the large increase in the dispersion of current account balances in the Euro Area. We investigate this hypothesis quantitatively. We develop an open economy New Keynesian model with search and matching frictions from which we derive robust sign restrictions for a wage bargaining shock. We then impose these restrictions on a Global VAR consisting of Germany and 8 EMU countries to identify a wage bargaining sho...

German Exports: Impact on the Selected EU Countries

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“…4 Our model suggests that wage moderation, tradable sector growth and a current account surplus in Northern Europe do not (only) reflect prudent policies, but also the consequences of unification. In this way, we complement not only the SOE literature, but also studies by Gadatsch et al (2016) and Bettendorf and León-Ledesma (2015), who focus on the extent to which German economic policies have driven euro area imbalances. Second, our modeling approach takes into account that the interest rate shock hitting Southern Europe was large and long-lasting and allows for monopolistic competition and differing levels of productivity between regions and sectors.…”

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