Optimal exchange rate flexibility with large labor unions

Vincenzo Cuciniello and Luisa Lambertini

Journal of International Money and Finance, 2016, vol. 63, issue C, 112-136

Abstract: We study the optimal volatility of the exchange rate in a two-country model with sectoral non-atomistic wage setters, non-traded goods, nominal rigidities and alternative pricing assumptions – producer or local currency pricing. Labor unions internalize the sectoral impact of their wage settlements through firms' labor demand. With local currency pricing, exchange rate depreciation raises sales revenue, which in turn boosts domestic consumption and labor demand. Unions anticipate this effect and set higher wages accordingly. With small unions and low wage markup, optimal monetary policy enhances exchange rate movements to improve its terms of trade. With large unions and high wage markup, optimal monetary policy curbs exchange rate movements to restrain inflationary wage demands and to stabilize employment.

Keywords: Exchange rate flexibility; Local currency pricing; Non-atomistic labor unions; Optimal monetary policy (search for similar items in EconPapers)
JEL-codes: E52 F3 F41 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:63:y:2016:i:c:p:112-136

DOI: 10.1016/j.jimonfin.2016.01.001

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