Labor market institutions and inflation volatility in the euro area |
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Authors: | Alessia Campolmi Ester Faia |
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Affiliation: | a Central European University, Economics Department, Budapest, Hungary b Magyar Nemzeti Bank, Research Department, Budapest, Hungary c Goethe University Frankfurt, Department of Money and Macroeconomics, Frankfurt, Germany d Kiel IfW, Kiel, Germany e CEPREMAP, Paris, France |
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Abstract: | Despite having had the same currency for many years, EMU countries still have quite different inflation dynamics. In this paper we explore one possible reason: country specific labor market institutions, giving rise to different inflation volatilities. When unemployment insurance schemes differ, as they do in EMU, reservation wages react differently in each country to area-wide shocks. This implies that real marginal costs and inflation also react differently. We report evidence for EMU countries supporting the existence of a cross-country link over the cycle between labor market structures on the one side and real wages and inflation on the other. We then build a DSGE model that replicates the data evidence. The inflation volatility differentials produced by asymmetric labor markets generate welfare losses at the currency area level of approximately 0.3% of steady state consumption. |
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Keywords: | Inflation volatility Labor market institutions EMU |
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