The Need for Labor-Market Flexibility in a European Economic and Monetary Union

Abstract

Summary This paper discusses the likely adjustment problems in European labor markets when there is an economic and monetary union (EMU) and a single currency. The discussion focuses on the need to improve the flexibility of European labor markets when the union's rules constrain monetary and fiscal policy. The paper examines the structure of production and trade in European countries and identifies some sources of asymmetric shocks. The most likely source is in the structure of trade, because European countries are exposed to a diversity of foreign markets. When asymmetric shocks occur, money wages and prices must adjust more when the EArfU constraints are in operation. An examination of the evidence pertaining to nominal inertia reveals little about the determinants of inertia and sheds no light on the question of whether inertia will change once the union is formed. If anything, the anti-inflation stance of a future European Central Bank may well increase nominal inertia in wage setting. Employment policies can help labor-market adjustments inside the EMU. But except for the social safety net, where there are some grounds for a common European policy, there appear to be no reasons in favor of a common employment policy in Europe. The different conditions in local labor markets and our lack of knowledge about the best policy in each case call for more flexibility in the choice of policies, with potentially beneficial knowledge spillovers across countries. w

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