Labor Market Institutions and Inflation Volatility in the Euro Area

Authors

  • Alessia Campolmi
  • Ester Faia
Publication Date

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 labour markets generate welfare losses at the currency area level of approximately 0.3% of steady state consumption.

Info

JEL Classification
E52, E24

Key Words

  • EMU
  • inflation volatility
  • labor market institutions