Central bank independence, centralization of wage bargaining, inflation and unemployment: Theory and some evidence

This paper proposes a conceptual framework to investigate the effects of ce ntral bank independence, of the degree of centralization of wage bargaining and of the interaction between those institutional variables, on real wage s, unemployment and inflation, in a framework in which unions are averse to inflation. This aversion moderates unions' wage demands as they attempt to induce the central bank to inflate at a lower rate. An increase in the deg ree of centralization of wage bargaining (a decrease in the number of union s) triggers two opposite effects on real wages, unemployment and inflation. It reduces the substitutability between the labor of different unions and therefore the degree of effective competition between them. This 'reduced c ompetition effect' raises real wages, unemployment and inflation. But the d ecrease in the number of unions also strengthens the moderating effect of i nflationary fears on the real wage demands of each union. This 'strategic e ffect' lowers real wages, unemployment and inflation. For sufficiently infl ation averse unions the interaction between those two effects produces a Ca lmfors-Driffill type relation between real wages and centralization. The pa per analyzes the effects of central bank independence on the position and t he shape of this relation, as well as on inflation and unemployment.The pap er features two mechanisms, one of which is novel, through which monetary i nstitutions have real effects. The model implies that if there is a single union social welfare is maximized when the central bank attaches a zero wei ght to inflation. But when the number of unions is larger than one this res ult is no longer true in general. Empirical evaluation of some of the theor etical implications, using data from 19 developed economies, is for the mos t part supportive of those implications. (C) 1999 Elsevier Science B.V. All rights reserved.