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Monetary Policy Delegation, Labour Market Structure and Fiscal-Monetary Policy Coordination

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  • Castrén, Olli
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    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.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/DP_14_1998.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 14/1998.

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    Length: 33 pages
    Date of creation: 08 Jul 1998
    Date of revision:
    Handle: RePEc:hhs:bofrdp:1998_014

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    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Related research

    Keywords: trade union behaviour; fiscal-monetary coordination; inflation targeting;

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    1. Cukierman, A. & Lippi, F., 1998. "Central Bank Independence, Centralization of Wage Bargaining, Inflation and Unemployment: Theory and Evidence," Papers 332, Banca Italia - Servizio di Studi.
    2. Henrik Jensen, 1992. "Time inconsistency problems and commitments of monetary and fiscal policies," Journal of Economics, Springer, vol. 56(3), pages 247-266, October.
    3. Herrendorf, Berthold & Neumann, Manfred J.M., 1998. "The Political Economy of Inflation and Central Bank Independence," CEPR Discussion Papers 1787, C.E.P.R. Discussion Papers.
    4. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 195-225.
    5. Beetsma, Roel M. W. J. & Bovenberg, A. Lans, 1997. "Central bank independence and public debt policy," Journal of Economic Dynamics and Control, Elsevier, vol. 21(4-5), pages 873-894, May.
    6. Andrew Oswald, 1984. "Efficient Contracts are on the Labour Demand Curve: Theory and Facts," Working Papers 555, Princeton University, Department of Economics, Industrial Relations Section..
    7. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
    8. Alesina, Alberto & Tabellini, Guido, 1987. "Rules and Discretion with Noncoordinated Monetary and Fiscal Policies," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 619-30, October.
    9. Huang,H. & Padilla,A.J., 1995. "Fiscal Policy and the Sub-Optimality of the Walsh Contract for Central Bankers," Papers 9522, Centro de Estudios Monetarios Y Financieros-.
    10. Robert J. Barro & David B. Gordon, 1984. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
    11. Canzoneri, Matthew B & Nolan, Charles & Yates, Anthony, 1997. "Mechanisms for Achieving Monetary Stability: Inflation Targeting versus the ERM," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 46-60, February.
    12. Stanley Fischer, 1995. "Modern Approaches to Central Banking," NBER Working Papers 5064, National Bureau of Economic Research, Inc.
    13. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
    14. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December.
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