Nominal Wage Flexibility and Monetary Union

The impact of the creation of a monetary union on structural convergence among member countries remains an open question. A model of monetary union is presented in which national nominal wage flexibility is endogenous and may vary across countries. We use wage indexation as a proxy for nominal wage flexibility and show how the strategic interaction between the monetary union central bank and wage bargainers results in “outlier” countries choosing an optimal wage contract which creates a more flexible nominal wage. The model predicts that if national business cycles are not perfectly synchronized, the optimal response of labor market participants to the creation of a single currency may promote structural divergence among member countries.