Asymmetric labor market institutions in the EMU and the

volatility of inflation and unemployment differentials

By Mirko Abbritti and Andreas Mueller

Discussion by Leo de Haan

DNB/IMF workshop on preventing and correcting macroeconomic imbalances in the euro area

Amsterdam 13-14 October 2011

Contribution• It is important to distinguish between different labor

market rigidities in a currency union:

1. Unemployment rigidities (UR)

2. Real wage rigidities (RWR)

UR RWR

Phillips curve Steeper Flatter

Question 1

• Policy implication?

• Stimulate union wide RWR for flatter Phillips curve?

UR RWR

Phillips curve Steeper Flatter

Analysis scheme

• Currency union: Home region + Foreign region

Symmetric shock

Asymmetric shock

Symmetric labor market structure

Case 1

Asymmetric labor market structure

Case 2 Case 3

Case 1: Asymmetric shock with symmetric labor market structure

• Finding: UR and RWR have different effects on inflation and unemployment differentials

UR RWR

Volatility inflation differentials

+ 0

Volatility unemployment differentials

- +

Question 2

• Policy implication?

• Stimulate union wide UR for lower unemployment differentials due to asymmetric shocks?

UR RWR

Volatility inflation differentials

+ 0

Volatility unemployment differentials

- +

Case 2: Symmetric shock with asymmetric labor market structure

• Finding: Asymmetries in labor market structures deteriorate adjustment of currency union to symmetric shocks

UR asymmetry

RWR asymmetry

Volatility inflation differentials

++ +

Volatility unemployment differentials

+ ++

Paper makes policy implication clear

• Remove all labor market asymmetries. Because they deteriorate adjustment to symmetric shocks.

UR asymmetry

RWR asymmetry

Volatility inflation differentials

++ +

Volatility unemployment differentials

+ ++

New dimension: Two types of labor market asymmetry

‘Complements’

Home Foreign

UR + -

RWR + -

‘Substitutes’

Home Foreign

UR + -

RWR - +

‘Complements’

Home Foreign

UR - +

RWR - +

‘Substitutes’

Home Foreign

UR - +

RWR + -

Case of (any kind of) shock with asymmetric labor market structure

• => ‘Substitutes’ enforce effects of labor market asymmetries, while ‘complements’ offset them

Complements Substitutes

Volatility inflation differentials

+ +++

Volatility unemployment differentials

+ +++

Question 3

• Policy implication?

• Remove labor market asymmetries only/especially when these are substitutes?

Complements Substitutes

Volatility inflation differentials

+ +++

Volatility unemployment differentials

+ +++

Two general comments

General comment 1

• Paper focuses on volatilities of inflation and unemployment differentials

• However, policy focuses more on size and persistence of differentials

• Are these two analytical concepts fully compatible?

General comment 2

• Which policy trade-off between:

• Volatility of inflation differentials

• Volatility of unemployment differentials*

* Complication: how to define ‘inefficient part’ of unemployment fluctuations in real world?