Bargaining Structure and Nominal Wage Flexibility

In a model with heterogenous agents, wage setting by monopoly unions and monetary policy conducted by a central bank, we show that the duration of nominal wage contracts is u-shaped in the degree of centralization, with intermediate bargaining systems yielding contracts of shorter duration and thus more flexible nominal wages than both decentralized and centralized systems. We also find the optimal level of centralization of wage bargaining to be negatively related to the degree of heterogeneity in the economy. The theoretical predictions of the model are tested on OECD data. There is empirical support for the main results regarding contract length, while there is less support for the predictions regarding the level of centralization.