Regional adjustment dynamics

The aim of the paper is to develop a theoretical framework for analyzing regional adjustment processes after idiosyncratic shocks. The model builds on the macroeconomic approach with monopolistic competition on goods and labor markets. It is shown how interregional factor mobility affects wage-setting behavior and labor supply. The dynamics of this extended model are explicitly taken into account. For a special case we can derive the characteristics of the adjustment process analytically. Under certain conditions the model exhibits hysteresis, i.e. temporary shocks on the price level or the unemployment rate can have a permanent effect on production and potential labor supply. It is argued that a suitable method for investigating regional adjustment processes empirically would be a panel VAR approach with integrated and co-integrated variables.