STAGFLATIONARY CONSEQUENCES OF PRUDENT MONETARY-POLICY IN A UNIONIZEDECONOMY

Stylised models of the policy game between monetary policy makers and the private sector have suggested that discretionary policy regimes su ffer from an inherent inflationary bias and that pre-commitment to a t arget rate of inflation may be desirable. This paper shows that in the presence of labour unions, the monetary policy game can lead to radic ally different results: a central bank that is completely indifferent to the level of inflation may obtain outcomes with high employment rat es and zero inflation while 'prudent', inflation-averse, central banks generate stagflation with positive inflation and low rates of employm ent.