Discussion Paper Details

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Title: Market Deregulation and Optimal Monetary Policy in a Monetary Union

Author(s): Matteo Cacciatore, Giuseppe Fiori and Fabio Ghironi

Publication Date: November 2013

Keyword(s): Market deregulation, Monetary union and Optimal monetary policy

Programme Area(s): International Macroeconomics

Abstract: The wave of crises that began in 2008 reheated the debate on market deregulation as a tool to improve economic performance. This paper addresses the consequences of increased flexibility in goods and labor markets for the conduct of monetary policy in a monetary union. We model a two-country monetary union with endogenous product creation, labor market frictions, and price and wage rigidities. Regulation affects producer entry costs, employment protection, and unemployment benefits. We first characterize optimal monetary policy when regulation is high in both countries and show that the Ramsey allocation requires significant departures from price stability both in the long run and over the business cycle. Welfare gains from the Ramsey-optimal policy are sizable. Second, we show that the adjustment to market reform requires expansionary policy to reduce transition costs. Third, deregulation reduces static and dynamic inefficiencies, making price stability more desirable. International synchronization of reforms can eliminate policy tradeoffs generated by asymmetric deregulation.

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Bibliographic Reference

Cacciatore, M, Fiori, G and Ghironi, F. 2013. 'Market Deregulation and Optimal Monetary Policy in a Monetary Union'. London, Centre for Economic Policy Research.