Non-Atomistic Wage Setters and Monetary Policy

The purpose of the paper is to study the monetary policy implications of unionized labor markets in a New Keynesian framework. It is shown that, once the presence of large wage setters is taken into account, the degree of wage setting centralization and the aggressiveness of the central bank in stabilizing inflation jointly affect the equilibrium level of real economic activity in the long-run. The classical neutrality result is not challenged: a temporary shock to the policy instrument dies off in the long-run. A change in the policy rule, however, has a permanent real effect since it alters the steady state equilibrium level of employment. In addition, the central bank can control the degree of inefficiency of the economy pushing output towards Pareto efficiency without creating inflation. JEL Classification: E24, E52