Abstract

We study the gains from increased wage flexibility using a small open economy model with staggered price and wage setting. Two results stand out: (i) the effectiveness of labor cost adjustments on employment is much smaller in a currency union, (ii) an increase in wage ‡flexibility often reduces welfare, more likely so in an economy that is part of a currency union or with an exchange rate-focused monetary policy. Our …findings call into question the common view that wage ‡flexibility is particularly desirable in a currency union.