Kiel Working Papers, Kiel Institute for World Economics
No 1338:
Fiscal Policy, Labor Unions, Competitiveness and Monetary Institutions: Their Long Run Impact on Unemployment, Inflation and Welfare
Alex Cukierman and Alberto Dalmazzo
Abstract: OBJECTIVES AND MOTIVATION: This paper considers the impact
of interactions between competitiveness, fiscal policy and monetary
institutions in the presence of unionized labor markets on economic
outcomes and welfare in the long run. Two main classes of questions are
investigated. First, what is the impact of exogenously given labor taxes
and unemployment benefits on the choice of monetary policy by the central
bank, on the choice of nominal wages by unions, on the choice of prices by
monopolistically competitive firms and through them on unemployment,
inflation and welfare? A related question is, how does the level of
competitiveness on goods’ market affect the economy and welfare? Second,
how are labor taxes and redistribution chosen by a (Stackelberg leader)
fiscal authority whose objectives are a weighted average of social welfare
and of catering to the interests of political supporters, and how does the
general equilibrium induced by this choice affect welfare? The framework of
the paper is motivated by the European scene in which the fraction of the
labor force covered by collective agreements dominates wage setting in the
labor market. “PLAYERS” AND PAYOFFS: The model economy features labor
unions that maximize the expected real income of union members over states
of employment and of unemployment, a central bank that strives to minimize
the combined costs of inflation and of unemployment, and a continuum of
monopolistically competitive firms, each of which maximizes its profits.
The last part of the paper also features a fiscal authority that sets taxes
and redistribution so as to maximize a combination of social welfare and of
benefits to particular constituencies. Utility from consumption is
characterized by means of a CES, Dixit-Stiglitz, utility function and (as
in Sidrauski type models) money appears in the utility function.
METHODOLOGY AND “PLAYERS” STRATEGIES: The first question is investigated
within a three stage game in which labor unions move first and commit to
nominal wages and the central bank moves second and chooses the money
supply. In the third and last stage each of a large number of
monopolistically competitive firms picks its price. To deal with the second
class of questions the game is expanded to feature a preliminary stage in
which government chooses labor taxes and redistribution anticipating the
subsequent responses of the other players. General equilibrium is
characterized and used to find the impact of various economic and
institutional parameters.
58 pages, June 2007
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