A Union-bashing Model of Inflation Targeting

This paper shows that in an open two-sector economy, centralization of wage setting may be important in determining the employment (and welfare) effects of different monetary targets. By disciplining unions in the sectors open to international trade, exchange rate targeting yields higher employment than inflation targeting when wage-setting is more centralized in the open sector than in the shielded sector. When wage-setting centralization is higher in the shielded sector, we show that general price-level inflation targeting, while better than exchange rate targeting, is inferior to an inflation target that focuses more heavily on shielded sector prices. Copyright The editors of the "Scandinavian Journal of Economics" 2006 .