Quantifying the Benefits of Labor Mobility in a Currency Union

Unemployment differentials are greater between countries in the euro area than between U.S. states. In both regions, net migration responds to unemployment differentials, though the response is smaller in the euro area compared to the United States. We use a multi-country DSGE model with cross-border migration to quantify Mundell’s hypothesis that labor mobility could substitute for independent monetary policy in a currency union. If European migration rates were at U.S. levels, labor migration would reduce the standard deviation of unemployment differentials by about 25 percent and reduce the welfare cost of the currency union by half. While mobility reduces the cost of the currency union on average, Mundell’s conjecture does not hold uniformly throughout the euro area. For countries that primarily face demand shocks, labor mobility stabilizes inflation and unemployment and improves welfare. If supply shocks are dominant however, labor mobility increases the cost of being in a currency union by magnifying inflation volatility.