Fiscal-Monetary Policy Interactions in the Presence of Unionized Labor Markets

This paper develops a framework for studying the interactions between labor unions, fiscal policy, monetary policy and monopolistically competitive firms. The framework is used to investigate the effects of labor taxes, the replacement ratio, labor market institutions and monetary policymaking institutions on economic peformance in the presence of strategic interactions between labor unions and the central bank. Given fiscal variables, higher levels of either centralization of wage bargaining, or of central bank conservativeness are associated with lower unemployment and inflation. However the forward shifting of changes in either labor taxes or in unemployment benefits to labors costs is larger the higher are those institutional variables. The paper also considers the effects of those institutions on the choice of labor taxes and of unemployment benefits by governments concerned with the costs of inflation and unemployment, as well as with redistribution to particular constituencies. A main result is that, in general, higher levels of centralization and conservativeness induce government to set higher labor taxes.