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

  • Castrén, Olli
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    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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    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
    Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
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    1. Canzoneri, Matthew B & Nolan, Charles & Yates, Tony, 1996. "Mechanisms for Achieving Monetary Stability: Inflation Targeting Versus the ERM," CEPR Discussion Papers 1418, C.E.P.R. Discussion Papers.
    2. 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.
    3. Bovenberg, A.L. & Beetsma, R.M.W.J., 1997. "Central Bank independence and public debt policy," Other publications TiSEM d1fc1375-507c-445b-9b38-d, Tilburg University, School of Economics and Management.
    4. Cukierman, Alex & Lippi, Francesco, 1998. "Central Bank Independence, Centralization of Wage Bargaining, Inflation and Unemployment - Theory and Evidence," CEPR Discussion Papers 1847, C.E.P.R. Discussion Papers.
    5. Stanley Fischer, 1995. "Modern Approaches to Central Banking," NBER Working Papers 5064, National Bureau of Economic Research, Inc.
    6. Oswald, A. J., 1995. "Efficient contracts are on the labour demand curve: Theory and facts," Labour Economics, Elsevier, vol. 2(1), pages 102-102, March.
    7. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    8. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Working Papers in Applied Economic Theory 94-05, Federal Reserve Bank of San Francisco.
    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. 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.
    11. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    12. 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.
    13. 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.
    14. Henrik Jensen, 1992. "Time inconsistency problems and commitments of monetary and fiscal policies," Journal of Economics, Springer, vol. 56(3), pages 247-266, October.
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