Structural Reforms in a Monetary Union: The Role of the ZLB

Structural reforms that increase competition in product and labor markets may have large effects on the long-run level of output. We find that, in a medium scale DSGE model, a 10 percent reduction in product and labor markups increases output by nearly 7 percent after 5 years. The short-run transmission of these reforms, however, depends critically on the presence of the zero lower bound (ZLB). When monetary policy is at the ZLB, structural reforms may have perverse effects, as they increase deflationary pressures and delay the normalization of policy rates. Hence, contrary to conventional wisdom, we argue that labor market reforms should precede product market reforms.