Price Competitiveness Divergence in the Euro Area: The Level Matters!

The authors argue that the fixation on indices or growth rates in the current discussion around price competitiveness in the euro area and the policy proposals that emerged from entirely ignoring levels may be misleading. In order to assess divergences in price competitiveness across euro area countries, the decisive measure are levels, not growth rates nor indices. Unfortunately, whether price competitiveness has converged or diverged in the euro area can be answered neither with nominal nor with real unit labor costs. A rule calling for equal growth rates in nominal unit labor costs across countries would necessarily result in divergence in unit labor cost levels and would be equivalent to fixing real exchange rates. In a currency area where nominal exchange rates are fixed and labor mobility is still relatively low, it would certainly be absurd to postulate that real exchange rates should not be allowed to move.