Central Bank Independence, Centralization of Wage Bargaining, Inflation and Unemployment - Theory and Evidence

This paper proposes a conceptual framework to investigate the effects of central bank independence, of the degree of centralization of wage bargaining and of the interaction between those institutional variables, on real wages, unemployment and inflation. The labour market is characterized by the degree of centralization of bargaining and by the degree of trade unions’ inflation aversion. The latter leads each union to moderate its wage demands in order to induce the Central Bank (CB) to inflate at a lower rate. An increase in the degree of centralization of wage bargaining (a decrease in the number of unions) triggers two opposite effects on real wages, unemployment and inflation. The decrease in the number of unions reduces the substituability between the labours of different unions and therefore the degree of effective competition between them. This ‘reduced competition effect’ raises real wages, unemployment and inflation. But the decrease in the number of unions also strengthens the moderating effect of inflationary fears on the real wage demands of each union. This ‘strategic effect’ lowers real wages, unemployment and inflation. The interaction between those two effects produces a Calmfors-Driffill type relation between real wages and centralization. The paper analyses the effects of centralization and of independence on the position and the shape of this Calmfors-Driffill relation, as well as on inflation and unemployment. Some of the resulting implications are tested empirically, using data from 19 developed economies. Implications for the optimal degree of conservativeness and for European Monetary Union (EMU) are also discussed.