Monetary policy and nominal rigidities under low inflation

In most European countries, nominal wages are given in collective agreements or individual employment contracts, and the employer cannot unilaterally cut wages, even after the expiration of a collective agreement. Ceteris paribus, workers have a stronger bargaining position when they try to prevent a cut in nominal wages. If inflation is so low that some nominal wages have to be cut, worker’s stronger bargaining position requires higher unemployment in equilibrium. The upshot is a long run trade off between inflation and unemployment for low levels of inflation. The prediction that low inflation involves higher unemployment in Europe but not in the US is consistent with previous empirical findings.