Fiscal policy in a monetary union with downward nominal wage rigidity

Matthias Burgert, Philipp Pfeiffer and Werner Roeger



JEL classification
E3, F41, F45

Downward nominal wage rigidity, currency union, fiscal policy, nonlinear estimation


We estimate an open economy DSGE model to study the fiscal policy implications of downward nominal wage rigidity (DNWR) in a monetary union. DNWR has significantly exacerbated the recession in the southern euro area countries and is important for the design of fiscal policy. We show that a cut in social security contributions paid by employers (equivalent to wage subsidies) is particularly effective in a deep recession with limited wage adjustment. Such cuts strengthen domestic demand and international competitiveness. Compared to government expenditure increases, the reduction in social security contributions provides more persistent growth effects and enhances the fiscal position. Non-linear estimation methods establish a strong state-dependence of policy.