Faculty of Economics and Business Administration Publications Database

Labor Market Institutions and Inflation Volatility in the Euro Area

Campolmi, Alessia
Volume: 35
Number: 5
Pages: 793 - 812
Month: May
ISSN-Print: 0165-1889
Link External Source: Online Version
Year: 2011
Keywords: Inflation Volatility; Labor Market Institutions; EMU
Abstract: 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.