Empirical evidence based on the Phillips curve, which I shall discuss in greater depth in a minute, confirms that inflation in the euro area is less reactive to the 6 degree of resource use than it is in the United States. The euro area’s greater inflexibility in price formation has an impact on the mechanism for the transmission of monetary policy. Empirical analysis confirms that, if the European economy were as flexible as the US economy, a given interest rate hike would have a 7 greater impact on inflation. This has a direct implication for the desirable level of monetary policy activism. First of all, according to neo-Keynesian economic models, the greater the degree of price inflexibility, the higher the impact will be of a drop in the interest rate. Thus, for a given variation in the interest rate, the impact on economic activity tends to be greater in the euro area than it is in the United States. In other words, to achieve the same impact on economic activity as that achieved in the euro area, the Federal Reserve has to change the interest rate to a larger extent. Several studies have shown that in the negative phase of the cycle, even though the interest rate in the euro area is changed to a lesser degree than it is in the United States, the impact of monetary policy on economic activity is nevertheless stronger.
In deciding interest rates, central banks do not only look at the nature of economic shocks but also at the way in which those shocks are spreading to the economy and at the mechanism for the transmission of monetary policy. These characteristics are determined by institutions and practices that develop gradually by comparison with the time frame within which monetary policy influences economic trends, and thus the central bank tends to regard them as given. A distinctive feature of the euro area’s structural context is the level of both real and nominal market inflexibility. The Product Market Regulation indicator compiled by the OECD, which is often cited as a measure of market inflexibility, is 50% higher in the euro area than in the United States. All available indicators on real labour market inflexibility are higher in the euro area. One has but to recall the OECD indicator on Employment Protection Legislation, which is ten times weightier in the euro area than it is in the United States. Collective bargaining 4 mechanisms cover 76% of the euro area and only 14% in the United States. The most exhaustive empirical evidence is available for nominal inflexibility. The mean duration of consumer prices – a yardstick for measuring time used by retailers to change the price of  183; Christiano, L., R. Motto and M. Rostagno, “Shocks, Structures or Policies? A Comparison of the Euro Area and the US”, in Journal of Economic Dynamics and Control (due to be published very soon).