Understanding the gains from wage flexibility: the exchange rate connection

Citation

  • Galí J, Monacelli T. Understanding the gains from wage flexibility: the exchange rate connection. Am Econ Rev. 2016;106(12):3829-68. DOI: 10.1257/aer.20131658

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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.
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