Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/318168 
Authors: 
Year of Publication: 
2020
Series/Report no.: 
BCAM Working Paper No. 2005
Publisher: 
Birkbeck, University of London, Birkbeck Centre for Applied Macroeconomics (BCAM), London
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.
Subjects: 
Sticky Wages
Nominal Rigidities
New Keynesian Models
Monetary and Fiscal Policy
Exchange Rate Policy
Currency Union
Fiscal Theory of the Price Level
Bohn Rule
JEL: 
E32
E52
E60
F41
F47
Document Type: 
Working Paper

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