Working Paper BETA #2012-04

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Title : Currency devaluation with dual labor market : Which perspectives for the Euro Zone ?

Author(s) : Amélie Barbier-Gauchard, Francesco De Palma, Giuseppe Diana

Abstract : In this paper, we assume a world of two countries in a fixed exchange rate system. The main difference between the two countries lies in the features of their labor markets. In the home country, we assume the existence of a dual labor market, with formal and informal sectors. In the foreign country, the labor market is homogeneous and characterized by a nominal wage rigidity. In this context, the situation of labor market in each country is not optimal through a misallocation of workers between sectors in domestic economy, and unemployment in foreign economy. Our article shows that a devaluation of domestic currency implies a fall in production in each country, an increase in unemployment in foreign economy and a worse reallocation of workers by a growth of informal sector in domestic economy.

Key-words : efficiency wage, dualism, exchange rate, devaluation.

JEL Classification : F16, F41, J31