Wage Rigidity and Monetary Union

Abstract

We compare monetary union to flexible exchange rates in an asymmetric, three-country model with active monetary policy. We find that countries with a high degree of nominal wage rigidity benefit from monetary union, especially when they join other, similarly rigid countries. Countries with relatively more flexible wages tend to be worse off in unions with countries that have more rigid wages. We examine France, Germany and the UK and find that the welfare implications of monetary arrangements depend more on the degree of wage asymmetry than on other types of asymmetries and that the higher wage flexibility in the UK would make its participation in EMU costly.Several members of the European Union formed a monetary union in 1999. Others opted to remain outside. A great deal of academic and political debate has surrounded this event. It has focused both on the effects of EMU for macroeconomic stability in its participant countries and on the wisdom of remaining outside once a currency union has been formed.This debate has taken place more or less within the traditional Mundell-Fleming model and the associated optimum currency area (OCA) literature. A key result that has emerged from this literature (de Grauwe, 2001) is that the cost of participation in monetary union increases with:(a) dissimilarities in economic structure, and in particular, in the degree of asymmetry in the shocks, (b) the degree of nominal rigidities.Countries with rigid nominal wages (prices) and asymmetries may want to retain the exchange rate instrument in order to have an adjustment mechanism that could serve as a substitute for the lack of nominal price adjustment; see also Friedman's (1953) case for flexible exchange rates.The choice of the exchange rate regime is a special case of the more general issue of optimal monetary policy in an open economy. There is a new and fast expanding literature that uses the New Keynesian Model (NKM)to investigate the performance of alternative open economy monetary policy rules, the macroeconomic and welfare properties of alternative exchange rate regimes (Collard and Dellas, 2002;Devereux and Engel, 2003;Duarte, 2003;Kollmann, 2002) and the welfare implications of different degrees of international policy coordination (Canzoneri et al., 2002;Clarida et al., 2002;Pappa, 2004;Obstfeld and Rogoff, 2001). The message that emerges from this literature concerning the value of the exchange rate instrument is more mixed. The results depend on the currency denomination of trade, the structure (completeness) of financial markets, the type of policy rule considered and differences in size across countries. * We thank Mike Wickens, Milton Friedman and three anonymous referees for numerous valuable suggestions. Any remaining errors are ours.

Markets Integration and Macroeconomic. Dispersion in a Monetary Union

“…Parameters describing the dynamics of exogenous shocks are , , and . Parameters of the monetary policy rule are and (see Dellas and Tavlas, 2005). Finally, parameters related to capital accumulation decisions are set according to Bergin, Shin and Tchakarov (2007): the depreciation rate of capital is , the factor elasticity of the physical capital in the production function is , and the adjustment cost on capital accumulation is .…”

When Eastern Labour Markets Enter Western Europe: CEECs Labour Market Institutions Upon Euro Zone Accession

“…However, Dellas and Tavlas (2004) develop a theoretical model, where exactly the opposite is true -countries with a high degree of nominal wage rigidity benefit from monetary union, specially when they join other, similarly rigid countries. Conversely, countries with relatively more flexible wages tend to be worse off in unions with countries that have more rigid wages.…”

Fiscal consolidation and its cross-country effects

“…(see equation (27)), so the steady state system remains well de…ned in terms of equations and unknowns. The associated steady state solution is in Table A2.…”

“…27 Actually, we will study two subcases here: one in which sovereign premia may remain in this reformed steady state, as determined endogenously by equation (27), similarly to the status quo model; and one in which, not only public debt is reduced to 90%, but also sovereign premia are eliminated in the new reformed steady state, meaning that now we also impose Q = Q in equation (27). Obviously, the second case, the one without premia, is more ambitious.…”