Nominal Wage Flexibility in a Monetary Union

Abstract

Membership in a monetary union reduces the possibilities to counteract fluctuations in productivity by monetary policy. One condition for entrance not to lead to adverse unemployment performance is that wages are flexible with respect to productivity. Here I show that, depending on workers' risk aversion, the incentive for workers to choose more nominal wages flexibility may increase after entrance in a monetary union. The reason is that if nominal wages are fixed in long-term contracts, the abolishment of exchange rates decreases the risk in real wages. On the other hand, the common monetary policy increases the employment risk. Assuming that individuals' preferences do not change, the institutional change in monetary policy may increase wage flexibility in a monetary union.