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    Understanding the gains from wage flexibility in a currency union: the fiscal policy connection

    Okano, Eiji (2020) Understanding the gains from wage flexibility in a currency union: the fiscal policy connection. Working Paper. Birkbeck Centre for Applied Macroeconomics, London, UK.

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    Abstract

    I investigate two findings in Gali and Monacelli (2016, American Economic Review) which are (i) the effectiveness of labor cost adjustments on 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. First, I introduce a distorted steady state in the small open economy model of GM, in which employment subsidies to make the steady state efficient are not available, and replicate their two findings. Second, I introduce an endogenous fiscal policy rule similar to the Bohn rule with a government budget constraint into the model. The results suggest that while the first finding of Gali and Monacelli is still applicable, their second finding is not necessarily applicable. It is, therefore, possible that an increase in wage flexibility reduces welfare loss in an economy that is part of a currency union as long as wage rigidity is high enough. Thus, there is still scope to discuss how wage flexibility is beneficial in a currency union.

    Metadata

    Item Type: Monograph (Working Paper)
    Additional Information: BCAM Working Paper #2005. ISSN: 1745-8587
    Keyword(s) / Subject(s): Sticky Wages, Nominal Rigidities, New Keynesian Models, Monetary and Fiscal Policy, Exchange Rate Policy, Currency Union, Fiscal Theory of the Price Level, Bohn Rule
    School: School of Business, Economics & Informatics > BEI
    School of Business, Economics & Informatics > Economics, Mathematics and Statistics
    Research Centres and Institutes: Applied Macroeconomics, Birkbeck Centre for
    Depositing User: Isobel Edwards
    Date Deposited: 19 Jan 2021 12:03
    Last Modified: 19 Feb 2021 07:38
    URI: https://eprints.bbk.ac.uk/id/eprint/41141

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