The Interaction of Monetary Policy and Wages

This paper focuses on the interaction of monetary policy and wage formation in economies with strong labour unions. Government and unions are viewed as endogenous utility maximizers, and the macroeconomic consequences of their interaction are explored with the aid of some elements of game theory. It is shown: (a) how labour unions optimally adjust wages to prices following changes in monetary policy; (b) how the effectiveness of monetary policy is circumscribed without necessarily being completely nullified by the optimal reactions of unions; and (c) how the strategic interplay of government and unions can create a tendency to inflation and unemployment simultaneously.