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Labor market institutions and inflation volatility in the euro area

Journal of Economic Dynamics and Control, ISSN: 0165-1889, Vol: 35, Issue: 5, Page: 793-812
2011
  • 68
    Citations
  • 0
    Usage
  • 39
    Captures
  • 0
    Mentions
  • 0
    Social Media
Metric Options:   Counts1 Year3 Year

Metrics Details

  • Citations
    68
    • Citation Indexes
      47
    • Policy Citations
      21
      • Policy Citation
        21
  • Captures
    39

Article Description

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 labor markets generate welfare losses at the currency area level of approximately 0.3% of steady state consumption.

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