Understanding the gains from wage flexibility: the exchange rate connection

Galí, Jordi, 1961-; Monacelli, Tommaso

Understanding the gains from wage flexibility: the exchange rate connection

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Citation

Galí, J, Monacelli, T. Understanding the gains from wage flexibility: the exchange rate connection. 2013. handle: http://hdl.handle.net/10230/21807

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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.