Understanding the Gains from Wage Flexibility: The Exchange Rate Connection
American Economic Review · 2016 · Volume 106 · Issue 12
Abstract
We study the gains from increased wage flexibility using a small open economy model with staggered price and wage setting. Two results stand out: (i) the effectiveness of labor cost reductions as a means to stimulate employment is much smaller in a currency union, and (ii) an increase in wage flexibility often reduces welfare, more likely so in an economy that is part of a currency union or with an exchange-rate-focused monetary policy. Our findings call into question the common view that wage flexibility is particularly desirable in a currency union.
Keywords
General Aggregative Models: Keynes, Keynesian, Post-Keynesian, Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital, Aggregate Labor Productivity, Monetary Policy, Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy, Foreign Exchange, International Monetary Arrangements and Institutions, Open Economy Macroeconomics
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