Openness, Unionized Labor Markets, and Monetary Policy

This paper extends the micro-founded DSGE open economy model by incorporating unionized labor markets. Unlike the standard framework with atomistic unions, large labor unions consider broader economic conditions and internalize the impact of their wage settlements on the aggregate economy. By emphasizing the interplay between internal and external sources of economic distortions and monetary policy regimes, we demonstrate that the economy’s openness, the degree of wage-setting centralization, and different monetary policy regimes influence unions’ wage-setting behavior and macroeconomic outcomes. The analysis identifies three key effects—the monetary policy effect, the intertemporal substitution effect, and the open economy effect—that large unions internalize when adjusting their wage demands in response to policy actions and external conditions. This novel wage-based mechanism alters the New Keynesian Phillips curve, with implications for the conduct of monetary policy, particularly in shaping the economy’s response to shocks and equilibrium determinacy. The real effects of monetary policy shocks under different policy settings depend on large unions’ internalization effect. In a unionized labor market, the impact of monetary shocks on the real economy is amplified compared to the standard case with atomistic unions. Additionally, interactions among large unions, openness, and monetary policy regimes affect determinacy properties of equilibrium (i.e., uniqueness of the solution path) under various forms and timing of monetary policy rules. This paper offers new insights into how union coordination interacts with monetary policy regimes and trade openness to shape macroeconomic stability (uniqueness of rational expectations equilibrium) and the dynamic response of the economy to shocks. These findings enhance our understanding of monetary policy design in economies with strong large labor institutions and external trade exposure—an area that remains underexplored in the existing DSGE literature.