Why so much wage restraint in EMU? The role of country size - Integrating trade theory with monetary policy regime accounts

Marzinotto Benedicta

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Abstract: Using theoretical models about the interaction between monetary policy-making and wage bargaining institutions, some researchers had been predicting an acceleration in wage growth under EMU (Iversen and Soskice 1998; Iversen et al 2000; Cukierman and Lippi 2001). However, the empirical evidence shows that, after the formation of the monetary union, wage growth has remained under control or even decelerated. Of the numerous explanations advanced to account for this trend, the most promising seems the one proposed by Posen and Gould (2006), who argue that behind the generalised shift towards wage restraint is enhanced monetary credibility in EMU. Whilst building on a similar argument, this paper adds to it in important respects. First, I show that the effects of a monetary union depend on labour market institutions. Second, and most originally, I argue that a strategic interaction between the ECB and non-atomistic labour unions is possible only in the case of large countries, whose price behaviour can potentially affect EU-13 inflation. This leads to the main finding behind this paper, namely that the relationship between wage growth and economy size is hump-shaped, with wage restraint more present in large and small countries, and less so in countries of intermediate size. Differently from a large country like Germany, small economies are free riders with respect to the monetary regime, but they care nonetheless for cost competitiveness, even if to different degrees. On the other hand, intermediate countries are trapped “inbetween” because neither do they believe capable of affecting euro-zone inflation, nor do they look at cost competitiveness as key to their economic survival.

Keywords: Wage restraint; collective wage bargaining; EMU; openness; international trade (search for similar items in EconPapers)
JEL-codes: E50 F15 F41 J31 J51 (search for similar items in EconPapers)
Date: 2008-02
New Economics Papers: this item is included in nep-cba, nep-eec, nep-lab, nep-mac, nep-mon and nep-opm
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