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RESEARCH PRODUCT

Coping with Asymmetric Shocks in the EMU: The Role of Labour Market Flexibility

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The chapter discusses the economic conditions for the success of EMU when there is still a need for structural reforms in the markets of goods and services, and factors of production. In view of asymmetric shocks, experience shows that behaviour in nominal and real wage growth resulted in increased unemployment throughout the EU15. Fiscal policy, on the other hand, could mitigate to some extent the burden of wage adjustment, and could play an important role in improving productivity. In general, however, smooth shock-absorption requires a flexible wage formation process to circumvent low employment levels, but the risk of hysteresis would remain. To avoid the accumulation of wage and labour cost differentials, which finally result in a widening external cost-competitiveness divergence among Eurozone countries, wage bargaining behaviour should respect at least several rules. These norms for wage developments are the following: (i) maintain overall nominal wage developments consistent with the goal of price stability; (ii) keep real wage developments in line with productivity increases; (iii) keep wage demands from converging upwards and catching up with wage increases in neighbouring countries; and, (iv) wage agreements should also better take into account productivity differentials according to qualifications, skills and geographical areas.