Abstract
Policy makers’ incentives to undertake costly labor market reform depend on the international monetary system. A regime of noncooperative monetary policy is compared with monetary union. We find that noncooperative policy leads to more reform of factors that affect the inflation bias. Which regime leads to more reform of factors affecting labor market flexibility depends on the size of monetary policy spillovers and the degree of correlation of supply shocks. We show that monetary union produces higher expected inflation, but a lower variance of inflation. Welfare can be higher or lower with monetary union.
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