Labor Mobility and the Level of Unemployment in a Currency Union

Unemployment rates are substantially higher and more volatile in the euro area relative to the United States. The paper presented in this Mannheim Applied Seminar asks to what extent the lack of cross-country labor mobility can account for unemployment dynamics in Europe. The authors' analytical model incorporates frictions in the labor market as well as an endogenous migration decision. Firms are unable to freely adjust wages during economic contractions, generating an asymmetric distribution of unemployment over the business cycle. The model is calibrated to the dynamics of unemployment and net migration in a typical euro area country. An increase in labor mobility to that observed in the United States and holding all other parameters fixed would reduce the volatility of euro area unemployment by 40% and return 1 million unemployed to the workforce. The welfare cost to a typical euro area country of the currency union is 4.7 percent of permanent consumption; increasing labor mobility reduces this cost to about 4.1 percent.