SUPPLY-AND-DEMAND POLICIES IN AN ECONOMY WITH CENTRALIZED WAGE SETTING

This paper analyzes the efficacy of fiscal policy in an economy with centralized wage setting, extending the previous work in two directions. On the one hand we have considered the role of supply side policy and on the other hand we have generalized the previous analysis by considering that the Government can utilize more than one policy instrument, namely a supply side and a demand side instrument. The results obtained can be summarized as follows. The optimal policy rule can be apparently destabilizing in two cases: when the trade union shows a "very" aggressive wage policy in response to any change in employment, and when the demand policy in more effective than subsidies in controlling prices. It is then shown that the policy rules are able to fully insulate the economy from external shocks. Moreover the Government is able to fully realize a change in one of its objectives without negative feedback on the other.