What drives the labour wedge? A comparison between CEE countries and the Euro Area

We use a structural macroeconomic model with search and matching frictions on the labour market to analyse the differences in the business cycle fluctuations of the labour wedge between two CEE countries and the Euro Area. Our results indicate that the observed higher volatility of this wedge in the CEE region reflects mainly different characteristics of stochastic disturbances rather than country-specific features of the labour market. We also identify significant differences in the sources of labour wedge fluctuations across the considered economies. Overall, we find that the labour wedge movements and hence the welfare costs of business cycle fluctuations in Poland are connected with inefficient functioning of the labour market. To the contrary, wedge fluctuations in the Czech Republic and the EA seem to result from the financial frictions.