Wage Rigidity, Monetary Integration and Fiscal Stabilisation in Europe

Svend Erik Hougaard Jensen

No 96-18, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: Flexibility in fiscal policy is a necessary ingredient in a policy package for EMU. Even with strong endogenous shock absorbers, such as real wage flexibility, fiscal policy can speed up the stabilisation process in response to demand shocks. If real wages are rigid, as they typically are in Europe, fiscal policycannot remove the adverse effects of asymmetric supply shocks, but it can successfully limit the divergence between member states. Monetary flexibility, a possible option in the run-up to EMU, cannot completely make up for the stabilisation function of fiscal policy.

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