Recession has put many Eurozone labour markets under stress, particularly those in Mediterranean countries that have inflexible markets. As part of ongoing reforms, many have tackled the labour market – under the explicit encouragement of the EU and the ECB.
Of course, labour-market reforms and macroeconomic policy matter in their own right, but an emerging consensus on the resolution of the Eurozone crisis has firmly linked the two in the minds of policymakers and economists, as well as market forces (Wyplosz 2013). While the importance of labour reforms has been well documented, the interaction with macroeconomics has not. The empirical and theoretical literature shows that firing costs reduce hiring and firing (see, e.g., OECD 2004). The interaction of firing costs and macroeconomic policies, by contrast, has received little attention so far from empirical economists. There are good reasons for thinking the two are linked.
In our recent work, we argue that larger firing costs lead to a more severe policy trade-off for central banks – i.e. more price stability is associated with more inefficient employment fluctuations (Faia, Lechthaler and Merkl 2013). This is particularly worrisome in a monetary union with heterogeneous firing costs, such as the Eurozone, and calls for a harmonisation of firing costs across countries to make sure that the ECB can perform an efficient policy for all member states.
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