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Our study analyzes labor cost development before and after the introduction of the Euro in EU member states. We are motivated by the current debate on diverging labor costs and the role of national governments, and on possible institutional reforms like the installation of a supra- regional transfer scheme for compensation the asymmetric distribution of shocks and costs. Our approach is different o long-run convergence approaches. We ask whether the reactions of national wage formation processes against shocks converge or diverge in the European Monetary Union (EMU). The empirical method is closely related to the theory of endogenous currency areas, which assumes that a single currency and common monetary policy force agents to react in a similar way. Testing a structured model, we find that the impact of the currency union on wage formation through trade intensity, industry-specific shocks and financial integration is of minor relevance. Also, we find national tax policy to be a potentially decisive instrument that might contribute to a fragmentation of wage formation in the euro area.

Is the European Monetary Union an Endogenous Currency Area? The Example of the Labor Markets