Real wage rigidities, accommodative demand policies, and the functioning of EMU

Abstract

Real Wage Rigidities, Accommodative Demand Policies, and the Functioning of EMU. — The paper shows that the primacy of politics over economics in the decision to start EMU with eleven countries on January 1, 1999 could have serious consequences concerning the functioning and stability of EMU, in particular during the transition phase. The paper demonstrates empirically that real wages in EMU member countries are highly rigid by international comparison and that demand policies played a considerable role in absorbing adverse shocks in the past. Considering that real wages are unlikely to become much more flexible soon, and taking also into account that the use of demand policies in EMU is severely curtailed, it becomes clear that EMU will face a severe crisis if large asymmetric shocks do in fact occur.