WAGE BARGAINING AND SHOCK SENSITIVITY OF A SMALL OPEN-ECONOMY

This paper analyzes the effects of centralized bargaining over a nomin al wage (indexation) rule on a small open economy with fixed exchange rates. It is shown that the relative bargaining power of the confedera tion of employers and the union, respectively, affects not only the le vel of the endogenous variables but also their reaction to exogenous d isturbances. If the union's power exceeds a critical value, positive a ggregate demand shocks increase unemployment since the actual nominal wage rises more than the market clearing one. Moreover, if the union's power is sufficiently close to its upper bound, the overreaction of w ages becomes so large that positive aggregate demand shocks even lead to a decrease in output and employment, i.e., the multipliers become n egative.