Abstract
This paper develops a framework for studying the interactions between labor unions, fiscal policy, monetary policy and monopolistically competitive firms. The framework is used to investigate the effects of labor taxes, the replacement ratio, labor market institutions and monetary policy-making institutions on economic performance in the presence of strategic interactions between labor unions and the central bank. Given fiscal variables, higher levels of either centralization of wage bargaining, or of central bank conservativeness are associated with lower unemployment and inflation. However the forward shifting of changes in either labor taxes or in unemployment benefits to labors costs is larger the higher are those institutional variables. The paper also considers the effects of those institutions on the choice of labor taxes and of unemployment benefits by governments concerned with the costs of inflation and unemployment, as well as with redistribution to particular constituencies. A main result is that higher levels of centralization and conservativeness induce government to set higher labor taxes if the replacement ratio and the tax wedge are sufficiently small.
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