Policy Credibility and Inflation in a Wage-Setting Game

This paper combines the conventional monetary policy game with a wage-setting game among several non-cooperating wage setters (each with some monopoly power). The inflationary bias in market economies is explained in terms of the wage competition bias. This bias does not disappear even when the central bank communicates its policy goals precisely and credibly. In a policy game with several non-cooperative monopolistic wage setters and a central bank, if discretionary policy is interpreted as wage setters' being Stackelberg leaders relative to the central bank, a discretionary policy leads to both higher inflation and lower output.