No. 1411 - The anatomy of labor cost adjustment to demand shocks: Germany and Italy during the Great Recession
The paper quantifies the flexibility of labor costs in Italian and German manufacturing firms in response to the demand shock caused by the global trade collapse during the Great Recession of 2008-09, using high-quality administrative data. In a currency area, such flexibility can play an important role in promoting the adjustment of relative prices and the recovery of competitiveness in the event of asymmetric shocks across countries.
In response to an exogenous decline in sales of 1 per cent, German firms reduced wages by 0.19 per cent, about double the decline observed for Italian firms. The decrease in employment was very gradual but more pronounced in Germany. Overall, the more marked adjustment of wages and, albeit delayed, of employment levels resulted in a greater and longer-term reduction in labor costs for German firms than for Italian ones.
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