infonet-economy

The real unit labor cost is an important variable in today's debate over competitiveness and labor cost imbalances in the Eurozone. This paper documents the link existing between developments in the labor share and relative monetary policy stance across euro area members. First I present the theoretical foundations of such link using a standard New Keynesian framework, then I investigate empirically this relationship using a panel of countries from the Eurozone. I find evidence that real interest rates differentials are key determinants of the evolution of real unit labor costs across Europe. Policy implications are significant as in the Eurozone the problem of divergent labor cost competitiveness cannot be separated from the one of differentials in monetary policy stance. Within this logic the reduction of State cross-differences in product and market frictions (structural reforms) are necessary but not sufficient for the elimination of labor cost imbalances. Other persistent sources of inflation differentials should be addressed as, for example, fiscal stance.