Costs of Exchange Rate Volatility for Labour Markets: Empirical Evidence from the CEE Economies

Abstract

According to the traditional ‘optimum currency area’ approach, little will be lost from a very hard peg to a currency union if there is little reason for using the exchange rate in response to economic shocks. This paper takes a different approach and highlights the fact that high exchange rate volatility may as well signal high costs for labour markets. The impact of exchange rate volatility on labour markets in the CEECs is analysed, finding that volatility vis-à-vis the euro significantly increases unemployment. Hence, the elimination of exchange rate volatility could be considered as a substitute for the removal of employment protection legislation.