Union wage setting and exchange rate policy

The performance of an optimally managed Boat is compared with that of a cre dibly fixed exchange rate in a small open-economy framework where wages are set by a monopoly union. Two key results emerge. First, a sufficient condi tion for the managed float to outperform a fixed rate is that the union be no less inflation-averse than society. Second, introducing an inflation tar get into the central bank's loss function ensures the superiority of the ma naged float regardless of the weight attached to inflation by the union. Bo th results reflect the sensitivity of the union mark-up to the policy regim e.