Labour Market Reform and Wage Bargaining in a Monetary Union

Abstract

This paper examines the effect of monopolistic labour unions' behavior on governments' incentives to undertake labour market reform, inside and outside a symmetric and an asymmetric monetary union (MU). Incentives for reform are increased inside the MU when governments and labour unions move simultaneously in the first stage of the policy game. Inside the MU there is also a possibility of a race to the bottom deregulation. This can be avoided by cooperation of the two governments, only in the case of a symmetric MU and in particular when unions are powerful in wage setting. Area-wide reform is above its pre-MU levels when labour unions have incentives to coordinate their wage setting decisions in an asymmetric MU. In that case the governments have no incentive to set reform in a cooperative manner, because this would lead to higher nominal wage demands by the union members.