DP6015 National Labour Markets, International Factor Mobility and Macroeconomic Instability

Author(s): Marta Aloi, Teresa Lloyd-Braga
Publication Date: December 2006
Keyword(s): fluctuations driven by self fulfilling expectations, indeterminacy, international capital movements, international labour movements, unemployment
JEL(s): E24, E32, F15, F20
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6015

We analyze how global economic integration of factor markets affects the stability of the macroeconomy, with respect to expectations-driven fluctuations, when countries differ in their labor market institutions. It is shown that, due to the occurrence of equilibrium indeterminacy, liberalization of capital movements is likely to be accompanied by persistent fluctuations at the world level, while allowing also for labor movements may bring macroeconomic stability. Whether this also implies higher welfare in the long run depends on differentials in average firm size across countries. If the average firm size in a country operating under perfect competition and full employment is small relative to a country with rigid wages and unemployment, then free migration reduces unemployment, narrows wage differentials and expands world output.