Macroeconomic effects of increased wage flexibility in EMU

Abstract

We analyse the macroeconomic effects of a more flexible wage setting process in the euro area. Reducing wage rigidities leads to far greater volatility in nominal wages, which ultimately translates into somewhat higher output and consumption volatility, while employment volatility is hardly affected. Even though volatility increases, the persistence of shocks is significantly reduced, which improves welfare of the union as a whole. We can show in a counterfactual analysis that, with lower wage rigidities, real GDP in the rest of the euro area would be higher and the unemployment rate lower compared to recent levels.