"Lower labour costs have ambiguous effects on domestic and foreign output in the presence of a transmission channel linking real wages with consumption and savings decisions of households. This transmission channel takes place via credit constrained households. The main result is that lowering labour costs in the home country has a positive impact on the domestic economy as the competitiveness effect dominates the lower labour income/lower domestic consumption effect. However, lower labour costs may produce a significant beggar-thy-neighbour effect in the open economy case for a large set of parameters. The relative strength of the beggar-thy-neighbour effect depends in particular on the relative size of the two households' populations, on home bias and the substitution between home and foreign goods, as well as on the reaction of monetary policy to inflation. Lastly, lowering labour costs in the home country is detrimental to both the home country and the foreign country in the presence of a zero lower bound in the nominal interest rate."

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