Monetary Institutions, Monopolistic Competition, Unionized Labor Markets and Economic Performance

University of Siena, Department of Economics Working Paper

44 Pages Posted: 24 Mar 2000

See all articles by Fabrizio Coricelli

Fabrizio Coricelli

University of Siena - Department of Political and International Sciences ; Paris School of Economics (PSE); Centre for Economic Policy Research (CEPR)

Alex Cukierman

Tel Aviv University - Eitan Berglas School of Economics; Interdisciplinary Center (IDC) Herzliyah; Centre for Economic Policy Research (CEPR)

Alberto Dalmazzo

University of Siena - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: January 2000

Abstract

Existing literature on the strategic interaction between the central bank (CR) and unions assumes that firms face perfect competition on product markets and that inflation is chosen directly by the monetary authority. Although these simplifications have the virtue of making complex strategic interactions more tractable, they abstract from the fact that, in reality, prices are set by firms and that the monetary authority affects the price level and inflation by determining the money supply. This paper makes a step in the direction of realism by recognizing that prices are set by monopolistically competitive firms and that the monetary authority affects the price level and inflation indirectly through its choice of money supply. This is done in a three stage game, in the first stage of which unions contractually set nominal wages, in the second stage the CB chooses the money supply, and in the third stage each firm chooses its individually optimal price. A sample of the paper's results follows: 1. In spite of full price flexibility, changes in the degree of conservativeness of the CB affect employment and output even when inflation is fully anticipated by labor unions and even when unions are indifferent to inflation. 2. When the CB is sufficiently conservative it reduces the money supply in response to wage increases. Both casual and econometric evidence suggests that such a mechanism has been in evidence in Germany where the Bundesbank often tightened monetary policy in response to "excessive" wage settlements. 3. Recent results concerning the optimality of a populist or "ultra liberal" CB are shown to be the exception rather than the rule. In particular, in many circumstances, an ultra conservative CB reduces both inflation and unemployment sufficiently to make the appointment of such a bank socially optimal. Intuitively when the CB is more conservative each union correctly anticipates a stronger contractionary reaction to an increase in its wage and, therefore, a stronger increase in unemployment among its members. As a consequence, the deterring effect of unions' fears from unemployment on their wage demands is stronger and employment higher when the CB is more conservative.

JEL Classification: E24, E58

Suggested Citation

Coricelli, Fabrizio and Cukierman, Alex and Dalmazzo, Alberto, Monetary Institutions, Monopolistic Competition, Unionized Labor Markets and Economic Performance (January 2000). University of Siena, Department of Economics Working Paper, Available at SSRN: https://ssrn.com/abstract=208293 or http://dx.doi.org/10.2139/ssrn.208293

Fabrizio Coricelli (Contact Author)

University of Siena - Department of Political and International Sciences ( email )

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Paris School of Economics (PSE)

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Centre for Economic Policy Research (CEPR)

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Alex Cukierman

Tel Aviv University - Eitan Berglas School of Economics ( email )

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Israel
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Interdisciplinary Center (IDC) Herzliyah ( email )

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HOME PAGE: http://www.tau.ac.il/~alexcuk/

Centre for Economic Policy Research (CEPR)

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United Kingdom

Alberto Dalmazzo

University of Siena - Department of Economics ( email )

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Italy
+39 0577 232 697 (Phone)

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