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Labor market institutions and inflation volatility in the euro area

Alessia Campolmi and Ester Faia ()

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Abstract: 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.

Keywords: Inflation volatility; Labor market institutions; EMU (search for similar items in EconPapers)
Date: 2011-03-03
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Published in Journal of Economic Dynamics and Control, 2011, 35 (5), pp.793. ⟨10.1016/j.jedc.2010.07.001⟩

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DOI: 10.1016/j.jedc.2010.07.001

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