Understanding the working of labor markets is crucial to understand inflation and unemployment dynamics. Over recent years, many voices have risen to advocate reforms to make labor markets more flexible. The conventional view among policy makers is that more flexible labor markets are needed in order to "improve the effectiveness of monetary policy by facilitating price stability" (Trichet, 2007). Moreover, flexible labor markets are believed to be important to facilitate the efficient adjustment of the economy to sectoral shifts and economic changes. Indeed, the perceived wisdom in European policy circles is that there is a need for more flexible labour markets in the context of the EU, particularly at the national and regional levels.However, most of these voices do not specify what labor market flexibility actually means.
The aim of this paper is to shed some light, both theoretically and empirically, on three related issues: (1) Are labor market institutions really important for inflation and unemployment dynamics and, if yes, how? (2) What does labor market flexibility mean? (3) How important are interactions among different labor market institutions?
Market foreclosure has for a long time been the prime policy concern in the context of vertical integration. The idea is that the integrated firm may have an incentive to exit the upstream market. Withdrawing from the upstream market might for example lead to a strategic gain in the sense that it increases the costs of downstream competitors. An integrated firm may also want to save fixed costs by concentrating marketing and advertising expenses to the downstream market. In any case, there is a risk that market foreclosure will harm competitors as well as consumers. Upstream competitors will have fewer outlets, downstream competitors may experience an increase in cost and final consumers may suffer from increases in price.
Recently, the European Commission has decided to implement a simplified procedure when dealing with merger applications in the case of vertical integration. Basically, if the combined market shares of the merging firms are less than 25 percent, upstream and downstream, the Commission will consider the merger harmless. A merger that fails the test could still be approved but only after a thorough evaluation.
Monetary economists have frequently expressed the view that the financial system is an important source of and propagation mechanism for cyclical fluctuations. Indeed, Keynes (1936), Simons (1948), Friedman (1960) and many others have argued that the free and unregulated operation of financial markets can lead to indeterminacy of equilibrium and "excessive economic fluctuations," even in the absence of shocks impinging on the rest of the economy. In modern terms, this argument claims that the financial system itself is a source of endogenously arising economic volatility.
This view has a long empirical foundation. Most of the pre-World War II recessions were associated with substantial transfers of resources out of the banking system and into other assets. For instance, most of the pre-World War II recessions described by Friedman and Schwartz (1963) were associated with increases in the currency-deposit ratio. Particularly severe recessions were associated with particularly sharp increases in this ratio (that is, with bank panics). And even in the last three decades, several recessions have been accompanied by phenomena termed "disintermediation" or "credit crunches." In all of these episodes the volume of bank-extended credit declined, and "credit crunches" have often been associated with the increased incidence of non-price rationing of credit.
