Abstract
Since the collapse of the Bretton Woods system, some European countries have pursued discretionary exchange rate policies in order to maintain or enhance the international competitiveness of the traded goods sector. These countries, which typically feature centralized wage setting, have also tended to experience high nominal wage increases. The overall outcome may be described as a ‘devaluation-wage spiral’. This paper applies two models of repeated games to analyze the strategic interaction between an exchange rate setting policy maker and a wage setting trade union. It is shown how a devaluation-wage spiral may result from a conflict of interest over the real wage. It is also shown how reputational forces may provide a way out of the devaluation-wage spiral.
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