Do Labour Market Reforms Achieve a Double Dividend under EMU?

Do Labour Market Reforms Achieve a Double Dividend under EMU? Discretionary versus Rule-based Monetary Policy Revisited

High equilibrium unemployment and the inflation bias in some EU countries require fundamental reforms of labour-market institutions. Impacts of different monetary regimes inside and outside EMU on the incentives for labour- market reforms are examined in a Barro- Gordon framework from the perspective of a single country. Monetary policy (discretionary versus rule-based) and the degree of labour-market reforms are determined simultaneously. It can be shown that discretionary policy outside EMU leads to a higher degree of reforms than rulebased policy since in the former case reforms reduce both unemployment and the inflation bias. However, rule-based monetary policy inside EMU limits the benefits of reforms to a positive impact on employment. Nevertheless, total economy welfare under EMU is superior to the one under discretionary policy. Insofar as a superior instrument is available for the parallel reduction of the equilibrium inflation rate, namely a strict monetary policy rule, the higher degree of labourmarket reforms under discretionary monetary policy outside EMU only signals a kind of an overshooting. (JEL Classifications: E52, E61, J38)