Wage bargaining and inflation

This paper investigates the issue of time inconsistency of monetary policy in a game with perfect information and infinite repetitions. The private sector is described by a wage negotiation process between a labour union and a firm. Unlike in the standard literature, the model has the feature that as the distortion of the economy gets larger, namely as the bargaining power of the union increases, the reputational equilibrium with low inflation becomes more likely to occur. This finding is consistent with the observation that higher levels of the labour cost are not typically associated with higher levels of inflation.