1 The impact of the EMU Regime on Germany: Slow wage growth, real exchange rates and the reallocation of FDI

Abstract. EMU is affected by relatively significant and persistent inflation dispersion. While most of the literature investigating the lack of convergence looks at price levels, the incidence of the Balassa-Samuelson effect, cyclical factors and the interference of national labour market institutions, this paper adds a new dimension by focusing on the impact of the EMU framework itself on inflation dispersion to then consider its effects on international competitiveness. Taking Germany as a case study, this paper suggests that, in a monetary union, where prices and wages can be used as a substitute for internal exchange rate policies, inflation disparities may become key indicators of competitiveness, together with industry and technology characteristics. In a nutshell, we suggest that “excessive ” wage moderation is responsible for Germany’s negative inflation differential, with slow inflation further enhanced by the restrictive stance of the ECB, insofar as the latter fixes short-term interest rates with an eye at average inflation in the Euro-area, thus failing to address single countries ’ circumstances. So, paradoxically, more favourable industrial relations may drive an economy into an over-restrictive macroeconomic policy regime, through higher than average real interest rates. Yet, on the other hand, a low inflation rate has a positive impact on the country’s competitiveness translating into real exchange rate depreciation. A favourable intra-EMU exchange rate has boosted exports, whilst containin