*u = ,a θɪ Y (40)
β (1 - ɑ) ∖ηu η*u √
It is clear that labor market characteristics play a key role in determining equilibrium
inflation as well. In particular, the inflation rate is negatively affected by the elasticity
of labor demand. Moreover, equation (39) and (40) indicate an inflation bias. With no
precommitment of any kind for the monetary authority, this is a standard result in the
literature on the time inconsistency of monetary policies. We therefore can state that
Remark 3 The conventional wisdom that discretionary policymaking by the CB yields
an inflation bias, while leaving employment at suboptimal levels, still holds in an open
economy when the elasticity of labor demand is finite.
It is crucial at this point to compare the labor demand elasticity r/N and ηu so as
to assess the impact of macroeconomic institutions on employment and inflation. Before
doing that, it is worth noticing that if we assume identical labor demand elasticity, i.e.
ηu = 'fN and ηU = ηN, inflation is lower under a NMP than in a MU for a given level of
employment. Since the Phillips curve is flatter in a MU, the common CB has a stronger
incentive to inflate as long as the employment level is below the competitive one. Non-
atomistic trade unions anticipate the reduced cost faced by the common CB in terms of
inflation and demand for higher wages which, in turn, lead to higher inflation.
However as shown in the Appendix, the elasticities of money supply to nominal wage
differ among the two regimes and, consequently, the labor demand elasticity. Removing
the assumption of equality renders the framework richer. The labor market structure (i.e.
the labor demand elasticity) is in fact ultimately determined by the number of unions, the
elasticity μ∣∣∣∣ and ∕<∙/.//, when the monetary policies are uncoordinated, and ∣ιu with a
common CB (see equation (36) and (37)). Thus, in the following section we assess how
CBC, CWS and country size may modify the labor demand elasticity.
7.1 Role of central bank conservatism
How do employment and inflation depend on the CBC? Rewriting the labor demand
elasticity with respect to the real wage as follows26
|
= = ÊL____"_____+ ■ - 1_____Z_____ (41) 'ir k dlogW , _ + Пи dlogW , _ , ( ) — "γ∙ -LJ- — "γ∙ dωi 1 dωi 1 |
where Θn ≡ Θh ≡ 1 — ɑw and θu ≡ 1 — ɑ.
It is clear that a higher degree of conservatism has two opposing effects on labor
unions. On the one hand, a non-atomistic wage setter becomes aware of the fact that an
increase in her nominal wages causes higher inflation which, in turn, reduces employment
26The elasticity of labor is obtained by substituting the CB reaction function in terms of aggregate labor
into Ii = -σ[ωi — ω) + I and differentiating with respect to ωi.
15