Money and the Natural Rate of Unemployment

By Finn Ostrup | Go to book overview

14
The impact of uncertainty on wage
setting

14.1 Introduction

It is demonstrated in this chapter that the monetary regime can influence natural production, determined by the wage setters' preferences with respect to production/employment and the real wage, by affecting the fluctuation in functional relationships. The stochastic fluctuations affect natural production in situations where the wage setters through contracts fix the nominal wage at a certain level in a future time period.

The analysis shows that it depends on the economic structure and preferences whether natural production is increased or lowered when there is a rise in the fluctuation of functional relationships. This can be explained as follows. The point of departure is wage setters who optimise preferences with respect to the real wage and employment that are asymmetric with respect to production. When the nominal wage is set in advance through contracts, the wage setters are subjected to the fluctuations in production and the real wage which take place during the wage contract period. We assume that fluctuations in economic relationships are normally distributed. When wage setters attach relatively large importance to reaching a high real wage relative to high production, they will aim at a low mean level of production because this improves the prospect of maintaining a high real wage when the economy experiences shocks. The increased certainty for a high real wage is thus reached at the cost of a higher mean level of natural unemployment. The reverse happens when the wage setters attach relatively large importance to maintaining high employment relative to a high real wage. The wage setters aim in this case at higher production to prevent low values of production when there are fluctuations in functional relationships.

The analysis has clear implications for the choice of optimum monetary regime. According to the traditional analysis, based on Mundell (1961), a monetary regime should be chosen from the viewpoint of

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