Real exchange rate adjustment, wage-setting institutions, and fiscal stabilization policy: Lessons of the Eurozone?s first deca

Wendy Carlin ()

No 8918, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In terms of macroeconomic performance, the Eurozone?s first decade is a story of successful inflation-targeting by the ECB for the common currency area as a whole combined with the persistence of real exchange rate and current account disequilibria at member country level. According to the standard New Keynesian model of a small member of a currency union, policy intervention at country level is not necessary to ensure adjustment to country-specific shocks. Self-stabilization of shocks takes place through the adjustment of prices and wages to ensure that the real exchange rate returns to equilibrium. That this did not happen in the Eurozone appears to be related to the presence of non-rational wage-setters in a number of member countries. A related second departure from the New Keynesian model was the transmission of nonrational inflation expectations to the real interest rate, propagating easy credit conditions in countries with inflation above target. Problems of real exchange rate misalignment among members were exacerbated by the ability of Germany?s wagesetting institutions to deliver self-stabilization. The implications for policy focus on using fiscal policy to target the real exchange rate and / or on reforms to labour markets that deliver real exchange rate oriented wage-setting.

Keywords: Eurozone; Real exchange rate; Fiscal policy; New keynesian model; Wage-setting (search for similar items in EconPapers)
JEL-codes: E61 E62 E65 F41 O52 (search for similar items in EconPapers)
Date: 2012-03
New Economics Papers: this item is included in nep-cba, nep-eec, nep-mac and nep-opm
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Citations: View citations in EconPapers (9)

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Journal Article: Real Exchange Rate Adjustment, Wage-Setting Institutions, and Fiscal Stabilization Policy: Lessons of the Eurozone's First Decade (2013)
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