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4 - Heterogeneous Market Regulation and Divergence in a Currency Union

from Part II - Macroeconomic Implications of Reforms

Published online by Cambridge University Press:  31 March 2020

By
Mirko Abbritti  and
Sebastian Weber
Edited by
Nauro F. Campos ,
Paul De Grauwe  and
Yuemei Ji
Nauro F. Campos
Affiliation:
University College London
Paul De Grauwe
Affiliation:
London School of Economics and Political Science
Yuemei Ji
Affiliation:
University College London
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Summary

A potential driver of real income divergence across members of a currency union is their regulatory environment. We focus on the role of product and labor market regulations and assess their effects on long-term growth and on the adjustment to shocks in a two-country currency union DSGE model with endogenous growth. With endogenous growth, there is no reason to expect real income convergence. When regulation varies across countries, real income can diverge permanently, because different market regulations lead to different levels of investment in productivity enhancing technologies. This in turn causes different trend growth and inflation pressures. Furthermore, under symmetric shocks, heterogeneous regulation can cause temporary, but persistent divergence of output and inflation. The results are consistent with the disappointing productivity growth and inflation rates experienced in less reform-friendly union members in the euro area and suggest that differences in market regulation can play an important role for both long-run and short-run divergence in response to shocks.

Keywords

currency unionendogenous growthincome divergencelabor market regulationproduct market regulation
Type
Chapter
Information
Economic Growth and Structural Reforms in Europe , pp. 111 - 140
Publisher: Cambridge University Press
Print publication year: 2020

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