From Ivan Werning and Emmanuel Fahri:
We study the effects of labor mobility within a currency union suffering from nominal rigidities. When the demand shortfall in depressed region is mostly internal, migra- tion may not help regional macroeconomic adjustment. When external demand is also at the root of the problem, migration out of depressed regions may produce a posi- tive spillover for stayers. We consider a planning problem and compare its solution to the equilibrium. We find that the equilibrium is generally constrained inefficient, although the welfare losses may be small if the economy suffers mainly from internal demand imbalances.
We have examined the effectiveness of labor mobility in helping macroeconomic adjust- ment in currency unions plagued with nominal rigidities. Our findings, summarized below, develop and qualify one of the central tenets of the Optimal Currency Area litera- ture put forth by Mundell (1961) that labor mobility is a precondition for optimal currency areas.
Agents move out of depressed regions and achieve higher welfare. Their impact on the welfare of stayers is less straightforward. Our analysis has emphasized the origins, internal or external, of demand imbalances. When demand imbalances are mostly in- ternal, movers have little impact on the welfare of stayers. By contrast, when demand imbalances are mostly external, movers improve the welfare of stayers.
These considerations have normative implications. There is little scope for govern- ment interventions in mobility decisions when demand imbalances are mostly internal. By contrast, there is an important role for government interventions in mobility decisions when demand imbalances are mostly external. Optimal government interventions en- courage migrations out of depressed regions.