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IMF, HWWA-Institute for International Economics and Otto-von-Guericke University Magdeburg, respectively. We thank Francesco Lippi and a referee for helpful comments and suggestions on an earlier version of this paper.
Another moderating effect of central bank conservatism is discussed in Soskice and Iversen (2000) and Coricelli and others (2000). In their monopolistic competition frameworks, a conservative central bank will ran a less accommodative policy when unions raise nominal wages and, consequently, firms’ prices. This policy change decreases employment and induces a more cautious wage-setting behavior. This moderating effect is increasing in central bank conservatism. Lawler (2000), in addition, shows that in a stochastic environment, central banks should not be ultra-liberal because they would produce excessively high inflation variance.
Note that this assumption is needed for making the case for the liberal central banker. The real non-neutrality of monetary policy as such does not depend on the trade union’s aversion to inflation (Lippi 1999b, Soskice and Iversen 2000). For examples from the earlier literature that already derived the non-neutrality result from the interaction of monopoly trade unions with (fiscal as well as monetary) policy regimes, see Driffill (1985) and Jensen (1993).
This might be the case because the stock of wealth is too low to matter for many trade union members or because state-supplied nominal benefits are means tested, making possibly existing private assets de facto a part of the public support scheme.
A trade union consisting of members capable of calculating the optimal wage-setting policy—including the inflation implied by any nominal wage rate set—in a multi-stage, multi-actor model is difficult to bring in line with the existence of non-indexed wealth. After all, a rational trade union member will not invest in, say, a nominal government bond without taking into account expected inflation.
To see this, substitute for n from the first order condition (15) and rearrange to find Vww = −(1−θ)δbrealp/w.
Note that for dp/dc> 0, we have no inner solution. If increasing c unambiguously increases inflation, the outcome is completely undetermined. As long as p > 1, there is no reason for a conservative central bank, as both government objectives are served best by a completely permissive monetary policy. Choosing c = 0, i.e., the case for an “ultra-liberal” central bank, made by Cukierman and Lippi (1999) and Guzzo and Velasco (1999), implies that prices are determined by the trade union rather than the central bank, which sets p = w c = 0 is only optimal for the government, however, as long as p > 1. If p < 1 at c - 0, we will have an inner solution for dp/dc > 0 with c >1.
Alternatively, we could argue that the government might not be able to commit itself to a zero level of nominal unemployment benefits in a time-consistent way. Then b¯might be the real outcome of the underlying political economic equilibrium.
B < 0 if n > (p-1)(δ −1). Otherwise, the second-order condition is not fulfilled for the case with the trade union facing a nominal outside option only.