Labor Market Institutions and the Political Economy of Exchange Rates
Project idea
This project seeks to analyze the influence of labor market institutions on the political economy of exchange rates. It focuses on the following dependent variables: sustainability of fixed currency regimes, preferences of interest groups over exchange rate regimes, and the influence on economic growth. Despite copious literature on these topics, existing empirical studies have so far neglected the impact of labor market flexibility.
This is surprising given that optimum currency area theory singles out labor market flexibility as an essential prerequisite for a successful functioning of a country that fixes its exchange rate or one that joins a single currency area. Therefore, one could advance the following hypothesis: among countries that have fixed exchange rates, the ones with higher labor market flexibility should be less prone to exchange rate crises and are more likely to sustain them. Second, those sectors that care more about competitiveness considerations (tradables) should be less opposed to fixing or joining the eurozone (and perhaps even support it) where labor market is more flexible. Third, the influence of fixed exchange rates on economic growth should be conditional on the level of labor market flexibility. These are the three main hypotheses of the proposed research.
The answers to the abovementioned questions have important academic and practical implications. First, they aim to provide an in-depth empirical investigation of widely accepted academic theories that have arguably become part of conventional wisdom. Second, they can help to address the current unsatisfactory state of affairs in the fields of international economics and political economy – there is at present little consensus on the determinants of exchange rate sustainability, interest group preferences, or the influence of currency regimes on economic growth. Third, these answers are important for countries deciding whether to join the eurozone or fix their currencies.
