The Issue of Instability in a Simple Policy Game between the Central Bank and a Representative Union

Faculty of Applied Economics UFSIA RUCA Working Paper No. 2002/09

20 Pages Posted: 28 Aug 2002

See all articles by Giovanni Di Bartolomeo

Giovanni Di Bartolomeo

Sapienza University of Rome, Department of Economics and Law

Wilfried Pauwels

Faculty of Applied Economics UFSIA-RUCA

Date Written: February 2002

Abstract

In the recent economic literature the independence of the central bank is often considered to be one of the most effective guarantees to achieve price stability. A strong theoretical basis of this proposition is that the monetary policy delegation given to an independent central bank is an optimal instrument to avoid the time inconsistency problem of monetary policy. This paper investigates the stability properties of this solution in a simple game in which the private sector (i.e. the trade unions) and the public sector (i.e. the central bank) simultaneously interact. A representative monopoly union is considered, and - in line with the recent economic debate - two types of unions are investigated: i) the standard micro-founded trade union; ii) the inflation-averse trade union. In both cases, we find that the requirement that the Nash equilibrium be stable imposes a limit to the conservativeness of the central bank. Instability of the Nash equilibrium reveals a strategic coordination failure between the public and the private sector.

Keywords: Central bank independence, inflation bias, inflation spiral, stability

JEL Classification: E52, E55, E61, J51, C62, C70

Suggested Citation

Di Bartolomeo, Giovanni and Pauwels, Wilfried, The Issue of Instability in a Simple Policy Game between the Central Bank and a Representative Union (February 2002). Faculty of Applied Economics UFSIA RUCA Working Paper No. 2002/09. Available at SSRN: https://ssrn.com/abstract=313399 or http://dx.doi.org/10.2139/ssrn.313399

Giovanni Di Bartolomeo (Contact Author)

Sapienza University of Rome, Department of Economics and Law ( email )

via Castro del Laurenziano 9
Roma, 00191
Italy

Wilfried Pauwels

Faculty of Applied Economics UFSIA-RUCA ( email )

Prinsstraat 13
Antwerp, B-2000
Belgium
+32 220 4122 (Phone)
+32 3 220 4026 (Fax)

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