Macroeconomic Volatilities and the Labor Market:First Results from the Euro Experiment

This paper analyzes the effects of different labor market institutions on inflation and outputvolatility. The eurozone offers an unprecedented experiment for this exercise: since 1999, nonational monetary policies have been implemented that could account for volatilitydifferences across member states, but labor market characteristics have remained verydiverse. We use a New Keynesian model with unemployment to predict the effects ofdifferent labor market institutions on macroeconomic volatilities. In our subsequent empiricalestimations, we find that higher labor turnover costs have a statistically significant negativeeffect on output volatility, while replacement rates have a positive effect, both of which are inline with theory. While labor market institutions have a large effect on output volatility, they donot seem to have much of an effect on inflation volatility, which can also be rationalized byour theoretical model....