EXCHANGE-RATE POLICY AND WAGE FORMATION IN AN ECONOMY WITH MANY TRADE-UNIONS

Exchange rate policy may confront governments with an important credibility problem. While there is usually a long run gain from abstaining from devaluations, there may also be a short run benefit from a devaluation. This short run benefit may cause expectations of future devaluations, resulting in wage and price rises that make the expectations self-fulfilling. This issue is analysed within a model with many trade unions. If the government pursues a non-devaluation policy, the trade unions gain from voluntary wage restraint. However, if the non-devaluation policy isn't credible, the cooperation on wage restraint may break down. © 1991.