Natural Unemployment, the Role of Monetary Policy and Wage Bargaining: A Theoretical Perspective

This paper models unemployment as a general equilibrium solution in labor and capital markets, while the natural rate hypothesis explains unemployment simply as a partial equilibrium in the labor market. It is shown that monetary policy can have long-run effects by affecting required returns on capital and investment. If monetary policy is primarily concerned with maintaining price stability, the interaction between wage bargaining and the central bank’s credibility as an inflation fighter becomes a crucial factor in determining employment. Different labor market institutions condition different monetary policy reactions. With centralized wage bar-gaining, a central bank mandate focusing primarily on price stability is sufficient. With an atomistic labor mar-ket, the central bank must also consider output as a policy objective