Research Discussion Papers, Bank of Finland
No 14/1998:
Monetary Policy Delegation, Labour Market Structure and Fiscal-Monetary Policy Coordination
Olli Castrén
Abstract: We study monetary policy delegation in a framework where
fiscal policy is determined endogenously and wages are negotiated by trade
unions who face a trade-off between real wages and employment. If the
median trade union voter is a senior member the nominal wages are too high
to guarantee full insider employment. The fiscal authority can subject the
central bank to institutional arrangements. The optimal choice of central
bank preferences shows a central banker who is more inflation averse, but
not infinitely so, than the fiscal authority. This happens because
employment and government expenditures are not invariant to changes in the
monetary regime. If the fiscal authority gives the central bank to an
inflation target, the optimal target is contingent upon both the fiscal
authority's and the trade union's preferences. Moreover, the fiscal
authority's gain from inflation targeting is highest if the median union
voter has no employment objective. When the union cares about employment,
both fiscal and monetary policies become subject to time-inconsistency
problems. In equilibrium, the overall welfare under inflation targeting can
be lower than under discretion. However, when the union's employment
objective becomes sufficiently important, the gain starts to increase.
Thus, we find a U-shaped relationship between the gain from inflation
targeting and the trade union's weight on employment.
Keywords: trade union behaviour; fiscal-monetary coordination; inflation targeting; (follow links to similar papers)
33 pages, July 8, 1998
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