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Understanding the Gains from Wage Flexibility: The Exchange Rate Connection

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  • Jordi Galí
  • Tommaso Monacelli

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 adjustments on employment is much smaller in a currency union, (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.

Suggested Citation

  • Jordi Galí & Tommaso Monacelli, 2015. "Understanding the Gains from Wage Flexibility: The Exchange Rate Connection," Working Papers 746, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:746
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    More about this item

    Keywords

    sticky wages; nominal rigidities; new Keynesian model; stabilization policies; exchange rate policy; currency unions; monetary policy rules;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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