The Impact of Exchange Rate Volatility on Labor Markets: Europe versus United States

Abstract

We analyze the effects of exchange rate volatility on labor market performance. We consider a simple Dixit/Pindyck-style model to show that there is a negative relationship between exchange rate variability and job creation. The uncertainty of future earnings raises the “option value of waiting” to create a job. A higher reservation wage, a better bargaining position of workers and higher costs of job creation strengthen the adverse impact of uncertainty on employment. Thus, the link between exchange rate variability and employment should be stronger in most European countries than in the US. Our regression analysis exactly confirms this conclusion. JEL classifications: E24, F33, F41

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