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WELFARE IMPLICATIONS OF HETEROGENEOUS LABOR MARKETS IN A CURRENCY AREA

Published online by Cambridge University Press:  16 September 2011

Céline Poilly
Affiliation:
Université Catholique de Louvain
Jean-Guillaume Sahuc*
Affiliation:
EDHEC Business School
*Corresponding
Address correspondence to: Jean-Guillaume Sahuc, EDHEC Business School, 24 avenue Gustave Delory, 59057 Roubaix, France; e-mail: jean-guillaume.sahuc@edhec.edu.

Abstract

To identify the labor market reforms that offer the highest payoff, we develop a medium-scale two-country model representing a currency union featuring real and nominal rigidities and heterogeneous labor market frictions. A labor market reform is modeled as a permanent structural change in the labor market institutions. We find that changes in the domestic labor market can have drastic welfare implications for both countries. Welfare improvements are observed when a worker (a firm) is more likely to find a job (a worker) or when jobs are less likely to be destroyed. In addition, labor market heterogeneity has sizeable effects on the level of welfare gains. The more flexible the foreign labor market, the higher its welfare. Finally, we show that (i) the way the monetary authorities conduct their policy has negligible welfare effects and (ii) matching frictions can offset the negative effect of price rigidities in the economy.

Type
Articles
Copyright
Copyright © Cambridge University Press 2011

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