Ten Years of the Euro

We now have a full decade of evidence concerning the impact of European monetary union on Ireland and the other member countries. While my view is that the euro has been beneficial in many ways, the next year or two will be highly revealing about the capacity of member countries to undertake economic adjustment while operating within the constraints of a common currency area.

The Economist has a nicely balanced article in its most recent edition: “Demonstrably Durable“, while John Hurley had an op-ed giving the local central bank view in the Irish Times on December 30th.

I gave my own view on the impact of the euro on Ireland in an article for the Sunday Business Post back in May: you can read it here.

I have also recently written a couple of academic survey papers on different dimensions of the euro:

EMU and Financial Integration,” IIIS Discussion Paper No. 272, December 2008. Prepared for the 5th Central Banking Conference of the European Central Bank.

The Macroeconomics of Financial Integration: A European Perspective,” IIIS Discussion Paper No. 265, October 2008. Prepared for the 5th Annual Research Conference of DG-ECFIN (European Commission).

Calmfors Driffill revisited

Everyone agrees that the Irish economy needs to restore competitiveness. Absent the possibility of devaluation, this either requires freezing nominal wages, and letting inflation erode their real value; or reducing nominal wages. The former course of action seems insufficient, since it will take too long, and we may even be heading for deflation.

So, the old Calmford Driffill literature from the 1980s may be relevant. (I couldn’t find their 1988 Economic Policy article online, but a survey article is here.)

Remember the basic point: if labour markets are very competitive, then wages will fall by themselves. If there are strong sectoral unions, on the other hand, then they may all play a game of ‘after you, my dear Alphonse’, and wages may not be cut. In that case, moving to central bargaining can help in coordinating wage cuts, in that no-one feels that they are falling behind in relative terms. Some would say that the introduction of social partnership in the late 1980s is a good illustration of that mechanism in practice. (OK, it involved wage restraint, not wage cuts, but that was useful in itself at the time, especially in the context of devaluation.)

The question for you all is: how flexible are private sector labour markets in Ireland today? We have all read about particular firms cutting wages, but how common is that? Are there studies on this? Will private sector wages fall sufficiently on their own, or is there a role for government coordination here?