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The political economy of twin deficits and wage setting centralization

Hamzeh Arabzadeh Jamali ()

No 2016017, Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) from Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES)

Abstract: This paper contributes to the literature on current account imbalances. Econometric analysis of the paper finds evidence that wage centralization, in a cross-section of industrialized economies, significantly improve current accounts through reducing budget deficits. To explain this empirical finding, the paper provides a political economy framework in which the government follows preferences of N-sector workers (majority rule). An increase in public and so, current account deficits by issuing external public debt leads to real appreciation of the currency. As between-sector mobility is constrained by friction in the labor market, wages in N-sector rises. The opposite happens if the government improves the two balances by rising its saving. Thus, N-sector workers relatively support (oppose) more a rise (reform) in the two deficits. Centralization of wage bargaining moderates the benefit and costs from such twin-deficit policies by reducing the responsiveness of sectoral wage with respect to sectoral prices. Thus, the more centralized is the wage determination, the less N-sector workers support (oppose) a rise (reform) in the two deficits. Correspondingly, more centralized wage bargaining reduces the government's political incentive (cost) to deteriorate (reform) the external balance through the fiscal balance.

Keywords: Twin deficits; Current account imbalances; Dutch disease; Search and Match; Wage bargaining Centralization; Real Exchange rate (search for similar items in EconPapers)
JEL-codes: F32 E62 J31 J51 J6 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-lab, nep-mac, nep-opm and nep-pol
Date: 2016-08-27
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