Mixed signals: central bank independence, coordinated wage bargaining, and European Monetary Union

Peter A. Hall and Robert J. Franzese

No FS I 97-307, Discussion Papers, Research Unit: Economic Change and Employment from WZB Berlin Social Science Center

Abstract: Plans for European Monetary Union are based on the conventional postulate that increasing the independence of the central bank can reduce inflation without any real economic effects. However, the theoretical and empirical bases for this claim rest onmodels of the economy that make unrealistic information assumptions and omitinstitutional variables other than the central bank. When the signaling problems between the central bank and other actors in the political economy are considered,we find that the character of wage bargaining conditions the impact of central bankindependence by rendering the signals between the bank and the bargainers moreor less effective. Greater independence can reduce inflation without majoremployment effects where bargaining is coordinated, but it brings higher levels ofunemployment where bargaining is uncoordinated. Thus, currency unions like the EMU may require higher levels of unemployment to control inflation than their proponents envisage; they will have costs as well as benefits, costs which will bedistributed unevenly among and within the member nations based on the changesinduced in the status of the bank and of wage coordination

Date: 1997
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