Why so much wage restraint in EMU? The role of country size - Integrating trade theory with monetary policy regime accounts

Using theoretical models about the interaction between monetary policy-making and wage bargaining institutions, some researchers had been predicting an acceleration in wage growth under EMU (Iversen and Soskice 1998; Iversen et al 2000; Cukierman and Lippi 2001). However, the empirical evidence shows that, after the formation of the monetary union, wage growth has remained under control or even decelerated. Of the numerous explanations advanced to account for this trend, the most promising seems the one proposed by Posen and Gould (2006), who argue that behind the generalised shift towards wage restraint is enhanced monetary credibility in EMU. Whilst building on a similar argument, this paper adds to it in important respects. First, I show that the effects of a monetary union depend on labour market institutions. Second, and most originally, I argue that a strategic interaction between the ECB and non-atomistic labour unions is possible only in the case of large countries, whose price behaviour can potentially affect EU-13 inflation. This leads to the main finding behind this paper, namely that the relationship between wage growth and economy size is hump-shaped, with wage restraint more present in large and small countries, and less so in countries of intermediate size. Differently from a large country like Germany, small economies are free riders with respect to the monetary regime, but they care nonetheless for cost competitiveness, even if to different degrees. On the other hand, intermediate countries are trapped “inbetween” because neither do they believe capable of affecting euro-zone inflation, nor do they look at cost competitiveness as key to their economic survival.Wage restraint, collective wage bargaining, EMU, openness, international trade

A European fund for economic revival in crisis countries

Significant volumes of Structural and Cohesion Funds have been pre-allocated but remain undisbursed or uncommitted. In Portugal, unused funds amount to 9.3 percent of GDP, in Greece close to 7 percent, and in central and eastern European countries about 15 percent. These funds should be part of a temporary European Fund for Economic Revival (EFER) for 2011-13, which would promote economic growth in crisis-hit countries and facilitate structural reforms. For countries under financial assistance in particular, the European Commission has a role to play in identifying the â??rightâ?? objectives for which the funds should be used. The Commission could decide to manage the funds directly with the support of an executive agency. Greater efforts should be made to exploit synergies between EU grants and European Investment Bank loans, allowing EIB loans to finance the total costs of a project or programme in small countries, and leveraging the whole EU budget to attract private investment.

How income inequality affects euro area current account imbalances

Since the late 2000s financial crisis, a great deal of attention has been focused on the issue of how inequality affects the lives of citizens. But can inequality also explain some of the macroeconomic trends present in European countries? Benedicta Marzinotto writes on the link between inequality and current account imbalances in the Eurozone. Using data going back to the beginning of Economic and Monetary Union, she argues that when capital accounts are fully liberalised and credit market regulation softened, income inequality does affect external positions

Income Inequality and Macroeconomic Imbalances under EMU. LEQS Discussion Paper No. 110/2016 May 2016

This paper explains the build-up and reversal of euro area macroeconomic imbalances by considering the interaction between the underlying income distribution in each country and EMU-induced financial liberalization. The argument is that the sharp increase in money supply since the early 1990s had the effect of relaxing collateral constraints for illiquid lowerincome groups, whilst having no specific impact on other households. The former started over-borrowing against optimistic expectations about their future income. It follows that unequal countries such as Greece, Ireland, Italy, Portugal and Spain - where the share of lower-income groups is relatively high - had greater private debt burdens and worse external positions than equal countries. Consequently, current account reversal was asymmetric because the crisis forced these indebted households to abruptly reduce consumption not least because they were the first to be pulled out of the labour market and hardly had financial buffers. The hypothesis is tested using a difference-in-difference approach to panel data

Current account imbalances, household consumption and debt in the Euro Area: a tale of two financial liberalizations

This paper explores the extent to which financial liberalization in the euro area had a differentiated impact on members\u2019 private consumption patterns and in turn on their current account positions as a function of who got indebted in the first place. Theoretically, it builds on an inter-temporal consumption model augmented with household heterogeneity. Low/middle income groups are impatient and credit-constrained, whilst high-income groups are patient and under no constraint. Increased access to credit in previously financially repressed countries implies a relaxation of collateral constraints specifically for low-income groups, who differently from high-income agents borrow to finance current consumption. It follows that financial liberalization is associated with deteriorating external positions there where initial levels of financial openness and inclusion are lowest and the share of the low/middle-income group largest

Employment protection and firm-level job reallocation: adjusting for coverage

This paper finds that employment protection legislation (EPL) had a significant impact on employmentadjustmentin Europe over 2001-2013, once we account forfirm-sizerelated exemptions to EPL. We constructa novel coverage-adjusted EPL indicator and find that EPL hinders employmentgrowth at the firm leveland increases the share of firms that remain in the same size class. This suggests that stricter EPL restrains job creationbecausefirms fear the costs of shedding jobsduringdownturns.We do not find evidence that EPL has positive effects on employment by limiting joblossesafter adverse shocks. In addition to standard controlsfor the share of credit-constrained firmsand the position in the business cycle, we also control forsize-related corporate tax exemptions and findthat thesealso significantly constrain job creation among incumbent firms

The euro complements Northern European economies more effectively than those in Southern Europe

Why has the Eurozone crisis affected Southern European countries more severely than Northern European countries? Benedicta Marzinotto writes that it is necessary for monetary and fiscal policies to complement structural factors within an economy, such as labour market institutions. She argues that the transition to the euro created problems for Southern European countries as the single currency’s macroeconomic regime was at odds with some of the structural features of these economies. In contrast, countries like Germany were shielded from these problems because the new system was similar to the previous German model

On the effectiveness and legitimacy of EU economic policies

For markets, European economic governance faces a crisis of policy effectiveness, while for citizens the European Union faces a democratic legitimacy crisis. The introduction of the European Semester economic policy surveillance system has not resolved these problems. Policy guidance deriving from the Semester is not focused enough on areas of significant spillovers and on problem countries, and national compliance is often procedural rather than actual. This brings into question both the Semester\u2019s effectiveness and the democratic legitimacy of the EU\u2019s new intervention rights, which allow intrusion into national policy-making

The long-term EU budget: size or flexibility?

The EU is in the process of negotiating its 2014-20 financial framework. Failureto reach an agreement would imply a delay in the preparation of the strategicplans each member state puts together to explain how it will use Structural andCohesion Funds. Even if solutions are found \u2013 for example annual renewals of the budget based on the previous year's figures \u2013 there will be political and ins-titutional costs. EU leaders have too often and too forcefully advocated the useof the EU budget for growth to be able to drop the idea without consequences.\u2022The overwhelming attention paid to the size of the budget is misplaced. EU lea-ders should instead aim to make the EU budget more flexible, safeguard it fromfuture political power struggles, and reinforce assessment of the impact of EU-funded growth policies.\u2022To improve flexibility a commitment device should be created that places theEU budget above continuous political disagreement. We suggest the creation of a European Growth Fund, on the basis of which the European Commissionshould be allowed to borrow on capital markets to anticipate pre-allocated EUexpenditure, such as Structural and Cohesion Funds. Markets would thus be afactor in EU budget policymaking, with a potentially disciplining effect. Atta-ching conditionality to this type of disbursement appears legitimate, as capitaldelivered in this way is a form of assistance

Current account imbalances, household consumption and debt in the euro area : a tale of two financial liberalizations

This paper explores the extent to which financial liberalization in the euro area had a differentiated impact on members’ private consumption patterns and in turn on their current account positions as a function of who got indebted in the first place. Theoretically, it builds on an inter-temporal consumption model augmented with household heterogeneity. Low/middle income groups are impatient and credit-constrained, whilst high-income groups are patient and under no constraint. Increased access to credit in previously financially repressed countries implies a relaxation of collateral constraints specifically for low-income groups, who differently from high-income agents borrow to finance current consumption. It follows that financial liberalization is associated with deteriorating external positions there where initial levels of financial openness and inclusion are lowest and the share of the low/middle-income group largest