2.5 Unions
The Home country is populated by a finite number of unions, n∏. Since all labor types
are unionized and equally distributed among unions, each union has mass 1∣nH. In our
setup the degree of centralization of wage setting (CWS) is equal to union size so that the
smaller is the number of unions, the more relevant is the impact of their wage settlement
on aggregate variables. In this respect the CWS is directly related to the unions’ capacity
to internalize the macroeconomic consequences of wage variations7.
The representative union is benevolent, i.e. it maximizes the utility of her members
under the workers’ budget constraint (4):
U Uj dj.
(15)
JjEi
We assume that each worker (and the union that represents her) takes profits as given8.
The Home union sets the same rate of growth of the nominal wage ω⅛ among her members
so as to maximize her own objective function. It is convenient to express the nominal
wage of worker i, Wi, and the CPI in the Home country as
Wi = 1 + Wi ; P =1 + π,
where π is domestic inflation rate9.
The benevolent union hypothesis is in line with the trade union behavior surveyed by
Oswald (1982) whose objective function usually includes real wages and unemployment10.
2.6 Central Bank
Drawing on the literature on time inconsistency in monetary policy, we assume that the
monetary authority is inflation averse and cares about the real performance in the economy,
which in our setup corresponds to agents’ utility11.
We draw on Lippi (2003) and assume that the common CB aims at maximizing the
following targeting rule:
7Drawing on Guzzo and Velasco (1999) we refer to such capacity as internalization effect.
8Aside from monopoly power, this adds an other distortion introduced in the model. Conversely, when
we present the CB problem below, the CB will allow for all economy-wide interactions so as to internalize
the effect of D on the welfare of agents.
9The previous period of nominal wage and inflation are nomalized to unity without loss of generality
since equilibrium outcome does not depend on it.
10Grhner and Hefeker (1999), Soskice and Inversen (2001), Cukierman and Lippi (2001) evaluate the
macroeconomic effect of monetary unification when unions are averse to inflation. However we focus on
microeconomic instead of macroeconomic foundations to analyze unions’ behavior.
11The paper investigates how the design of the monetary institution affects the country performance.
The notion of an inflation averse CB may be interpreted also as a kind of general institutional constraint
in the economy.