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1 results

  • 4 - Heterogeneous Market Regulation and Divergence in a Currency Union

  • from Part II - Macroeconomic Implications of Reforms
  • Edited by Nauro F. Campos, University College London, Paul De Grauwe, London School of Economics and Political Science, Yuemei Ji, University College London
  • Book:
    Economic Growth and Structural Reforms in Europe
    Published online:
    31 March 2020
    Print publication:
    02 April 2020, pp 111-140

  • 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.