Parties, Unions, and Central Banks:

An interactive model of unemployment in industrial democracies

Christopher Adolph
Harvard University
October 1, 2003

Abstract.
Many studies suggest that either partisan governments, labor market centralization, or central bank independence affect unemployment, but none
consider the full range of interactions among these institutions. I offer
a fully interactive model of unemployment and test it using quarterly
data from fifteen industrialized democracies over 24 years. Confiming
earlier work, I find central bank independence (CBI) and wage bargaining centralization interactively determine unemployment, with CBI having the greatest benefit in moderately centralized labor markets. Adding
partisan governments to this strategic interaction, I find that unemployment is subject to permanent, labor-market-contingent partisan cycles
in which the left always lowers unemployment. Both theory and evidence show larger cycles in moderately centralized economies with hawkish monetary authorities, suggesting left-wing government and monetary
non-accommodation are complementary in this case. One size does not
fit all, though: I find no benefit from CBI in centralized economies, and
a substantial unemployment cost in decentralized labor markets.

Ph.D. Candidate, Department of Goverment. (Littauer Center, North Yard, Harvard University, Cambridge
MA 02138; http://chris.adolph.name, cadolph@fas.harvard.edu).

1 Introduction
Over the past quarter century, political theories of economic performance focused on labor
market arrangements, then elections and partisan governments, and more recently central bank
institutions. Typically, these theories developed in isolation, grew in popularity, then faded into
the background. Recently, however, comparative political economy has revisited these ideas in
the context of richer, interactive models of economic performance, particularly regarding the
interplay of labor markets and central banks. Yet there has been little effort to update earlier
interactive models of parties and unions, and no tests for three-way interactions among parties,
unions, and monetary authorities. This paper fills that gap.
I develop a model of unemployment in which partisan governments and unions reach bargains exchanging wage restraint for social policy, with both sides anticipating the central bank
may respond to excessive wage demands with restrictive monetary policy. As in Iversens (1999)
model of strategic interaction between unions and central banks, the unemployment rate results
from the interplay of wage bargaining centralization and monetary accommodation. Introducing partisan governments to Iversens framework adds the possibility of wage-policy bargains
that lower unemployment. According to the model, these bargains will be most effective to the
extent that 1.) labor markets are moderately centralized, 2.) central banks are inflation hawks,
and 3.) governments are willing to spend significant sums to reduce unemployment.
Testing the model on a sample of fifteen industrial democracies over 24 years yields two
main empirical findings:
First, unemployment is subject to both temporary partisan cycles after elections and permanent partisan effects (both of which are consistent with rational expectations). In these
cycles, left government always lowers unemployment. Permanent partisan cycles are mediated
by the centralization of the labor market (as Lange and Garrett [1985] argue) and have maximum impact in moderately centralized labor markets (contra Lange and Garrett). Temporary
partisan cycles are unaffected by high central bank independence, while permanent partisan
cycles are actually larger where the central bank is non-accommodating.
Second, monetary and labor market institutions interactively determine unemployment,
with independent, conservative central banks having the greatest benefit in moderately centralized labor markets (flipping the Calmfors-Driffill curve, as Iversen [1999] argues). However, non-accommodating central banks have no discernable effect on unemployment in highly
centralized labor markets (against Iversens expectations), and cause a small but significant
increase in unemployment in decentralized economies, contrary to standard neoclassical theory
(but supporting Hall and Franzese [1998]).

2 The Political Economy of Economic Performance

Before considering interactive models of unemployment, I review three building blocks from
which these syntheses developed: theories of corporatism, central bank independence, and
partisan cycles. I proceed to pairwise interactions between these institutions, and finally a
fully interactive model. Readers may refer to Table 1 (p. 14) for a summary of each theorys
hypotheses regarding the impact of labor markets, partisan governments, and central bank
independence on unemployment.
2

2.1 Corporatism
In the 1980s, labor market structure was a popular explanation for better economic performance
in corporatist countries like Sweden, Austria, and Norway (Cameron 1984; Katzenstein 1985).
In an influential paper, Calmfors and Driffill (1988) suggested the relationship between labor
union concertation and economic performance might be hump-shaped, owing to two countervailing forces. The market power of unions to demand higher wages grows with the centralization
of wage bargaining (since the elasticity of demand for goods produced by a bargaining unit falls
as the unit grows to encompass entire industries). But at the same time, more encompassing
bargaining systems foster union restraint by internalizing the inflationary effects of wage demands (Olson 1982). Working against each other, these forces render industry level bargaining
the worst case, since sectoral concentration creates market power without containing temptations to raise nominal wages. According to Calmfors-Driffill, moving in either direction from
moderately centralized bargaining should improve economic performance. In one direction, the
market restrains decentralized unions wage demands, yielding better outcomes. In the other,
nationally coordinated labor markets may be the best case of all, since unions representing most
workers (and thus most consumers) will self-restrain to avoid negative aggregate outcomes.

2.2 Central Bank Independence

In contrast to the corporatist literature, which supposes that labor market institutions affect
inflation and unemployment, the central bank independence literature asserts the price-level is
determined by monetary policy alone. In particular, the literature presumes that individual
wage setters anticipate the monetary authoritys incentives to inflate, so monetary policy is
neutral with respect to unemployment and output. Since anticipated money supply growth
yields higher inflation and no real gain, governments should prefer to set their ideal inflation
rate by a rule. But this policy is plagued by time inconsistency (Kydland and Prescott 1977). To
whatever extent economic actors believe the promised rule, governments are tempted to create
unexpected money growth. And so long as the market rationally anticipates cheating, inflation
expectations and inflation itself will be higher than under a credible rule. Thus governments
preferring both low inflation and high output are better off credibly delegating authority to
a more conservative agentthe independent central bank (Barro and Gordon 1983; Rogoff,
1985). Some economists have argued that independent central banks empirically achieve price
stability at no real cost (Grilli, Masciandaro, and Tabellini 1991; Alesina and Summers 1993),
though in theory, central bank non-accommodation should increase the instability of the real
economy.

2.3 Partisan Cycles

While work on corporatism and central bank independence concerns the long term institutional
sources of economic performance, the political business cycle literature deals with transitory and
generally smaller variation in performance before and after elections. The rational expectations
revolution narrowly confined the role of partisanship in the economy, undercutting Hibbs (1987)
claim that partisan monetary policy had persistent effects on real economic variables. But
according to Alesina (1987), elections provide a temporary exception. Firms and unions writing
3

wage contracts before elections are unsure who will win, so contractual assumptions regarding
future inflation rates are bound to miss the mark in proportion to the surprisingness of the
elections outcome. This creates a brief post-election window for parties to use monetary
policy to real effect. Left elections will be followed by economic booms, and right victories
by recessions, but by the time most pre-election contracts lapse (say, two years), partisan
performance should be indistinguishable. Alesina, Roubini, and Cohen (1997) test this model in
the US and in 15 OECD countries, and find moderately-sized rational partisan cycles. Alesina,
Roubini, and Cohen also suppose partisan cycles will be less intense where central banks are
independent, on the presumption that central bank behavior will be unaffected by a change
in government. Surprisingly little evidence to support this hypothesis is forthcoming. Indeed,
some of the largest partisan cycles appear in Germany and the United States (Alesina and
Roubini 1990), countries with independent central banks. This lead Drazen (2000) to question
whether Alesinas partisan cycles derive from monetary policy at all, rather than fiscal policy.

2.4 The Parties and Unions Synthesis

In an early effort to examine the interactive effects of political economic institutions on performance, Lange and Garrett (1984) and Alvarez, Lange, and Garrett (1991) argue the effects
of labor market institutions depend on the party in power. Only if the left is in power can
encompassing unions be sure the benefits of restraint will go to workers, rather than the owners
of capital (Przeworski and Wallerstein 1982). Dependent on the labor movement for electoral
support, the left will pursue policies that ensure investment and employment remain high, fulfilling labors long run goals. But when the right is in office, encompassing unions may be
better off using their market power to win immediate wage gainsat the cost of higher unemployment and poorer long-term performance than under the left. On the other hand, where
unions are weak and market conditions more closely approximate the neo-classical model, right
governments may produce higher growth, lower unemployment, and lower inflation than the left
by pursuing laissez faire policies. According to Lange and Garrett, the optimal combinations
are weak unions and right government, or strong, encompassing unions and left government.
At moderate levels of union centralization and strength, partisan changes should make little
difference (Figure 1, left panel).

2.5 The Unions and Central Banks Synthesis

Political economists have recently focused on another institutional interaction. If labor market agents are not simply price takers, central banks must consider the behavior of wagesetting unions and employers when setting monetary policy. Thus any positive degree of wage
bargaining centralization may give real effect to monetary policy, since the threat of nonaccommodation by an independent central bank can lead a union to rethink its wage demands.
This innovation lies behind much recent work in comparative political economy. For example, Iversen (1998a,1998b,1999) models this strategic interaction by incorporating Calmfors
and Driffills insights into a two-stage game between wage-setting unions and inflation-setting
central banks. Cukierman and Lippi (1999) undertake a similar project, but reach different

Parties & Unions

(Lange & Garrett)

Parties & Central Banks

(Iversen)
Accommodating (low )

1.1

Unemployment

1.0

Right

0.9

Nonaccomodating
(high )

0.8

Nonaccom.,
Ineq. matters

0.7

Left

0.6
0.5
0.0

0.2

0.4

0.6

0.8

1.0

Centralization of Wage Bargaining

0.0

0.2

0.4

0.6

0.8

1.0

Centralization of Wage Bargaining

Figure 1: Two Interactive Models of Unemployment. The left panel shows Lange and Garretts
expected relationship between parties, labor markets, and unemployment: left government
complements a centralized labor market, and right government a decentralized economy. The
right panel shows equilibrium employment in Iversens model of union-central bank interaction
in three different scenarios: an accommodating central bank (dark line), a non-accommodating
central bank interacting with unions unconcerned with inequality (solid gray line), and a nonaccommodating central bank faced with unions that care about wage equality (dashed gray
line).

conclusions by changing a few assumptions. 1 And Hall and Franzese (1998) substitute labor
market coordination for centralization to yield a third set of hypotheses.
In Iversens model, wage setters weigh real wage demands against fears of unemployment
and wage inequality, while anticipating the central banks reaction (which balances inflation
and aggregate unemployment). Following Calmfors-Driffill, unions real wage setting power and
the inflation-cost of its own wages rise with wage bargaining centralization. Thus if the central
bank accommodates wage demands (as Iversen supposes it will if CBI is low), the relationship
between unemployment and centralization will be hump-shaped a la Calmfors-Driffil, but with a
non-accommodating central bank (high CBI), the hump is suppressed, or even inverted (Figure
1, right panel). For low (technically, zero) centralization, unemployment is unchanged, since
money remains neutral where unions are price-takers. In moderately centralized labor markets,
higher CBI lowers unemployment, since the banks credible threat discourages wage demands.
Yet for highly centralized economies, unions efforts to maintain wage equality may mitigate the
effectiveness of restrictive monetary policy, leading to higher unemployment under high CBI. 2
1

Specifically, Cukierman and Lippi assume that unions are organized by craft and care nothing for withinunion wage equality or economy-wide unemployment, and that labor is perfectly substitutable across industries
but not unions. Under these assumptions, higher CBI raises unemployment for all levels of wage bargaining, and
shifts the peak of the Calmfors-Driffill curve rightward.
2
According to Iversen, encompassing unions face pressure from the median wage-earner to maintain wage
equality, but find it difficult to impose wage compression on their most productive workers, who often receive
raises outside the bargaining agreement. To erode this wage drift, unions demand higher nominal wages

Hall and Franzese (1998) argue that union coordination better captures variation in the
strategic interaction of central banks and unions. Effective coordination offers the same benefit
as centralization by forcing the lead union to consider the inflationary consequences its demands
imply for the economy. Even seemingly decentralized labor movements may reliably coordinate
on the leading unions contract. An independent central bank can nudge a coordinated labor
market towards better economic outcomes by credibly threatening to punish inflationary wage
demands, but without labor market coordination, high CBI may actually raise unemployment.
Franzese (2001, 2002) argues that in this case, wage bargainers tend to be too small to credible
threaten with monetary non-accommodation (since monetary policy is indivisibly applied to the
whole economy, which may include hundreds of unions). Nevertheless, unions are often large
enough to exert some market power, so that their wage demands create incipient inflation
pressures. As centralization drops (but remains above zero), central banks will rely more on
pre-emptive action to slow the economy (undermining unions bargaining position and checking
inflation) and less on threats (which can be both credible and largely unused only when unions
are large). The upshot is negative real consequences of non-accommodation in low centralization
economies.
Despite diverse specifications and measures, most empirical work confirms the benefits of
high CBI in moderately centralized or coordinated economies (the one point on which most
theorists agree), while disagreeing about extreme cases. Though Iversen observes no effect
of CBI in decentralized economies, Hall and Franzese and Cukierman and Lippi find higher
unemployment where CBI is combined with uncoordinated economy labor markets. Finally,
the small number of observed cases of high centralization means even minor differences in
measurement can produce qualitatively different results. Using a finely grained measure of
centralization, Iversen finds that CBI substantially raises unemployment where labor markets
are most centralized, while other authors, using simpler codings of coordination, find slightly
lower unemployment in this case.

2.6 Parties, Unions, and Central Banks: A Unified Interactive Model

Lange and Garretts argument was groundbreaking, leading us to consider interactive institutional theories of political economy. It also supports the schema of complementarity, shared
by many political economists, that considers ideologically consistent economic institutions (be
they labor market structures, welfare state policies, or partisan governments) best for economic
performance. But we should be skeptical that left- and right-wing utopias are really the best
of all possible worlds. The idea that left-wing governments might suppress labor demands by
promising more social policy is a powerful one, but the emphasis on highly centralized labor
markets is misplaced. Surely in this case, left-wing governments need not offer social policy
to restrain unions, since encompassing unions already internalize the inflationary cost of wage
militancy. Instead, following a Calmfors-Driffill logic, the promise of social guarantees from the
left should matter most where unions are sorely tempted by their market powerin moderately
centralized labor markets. On the other hand, the exact benefit of right-wing government in
decentralized economies is not clear from Lange and Garrett, and may amount to the absence of
across the board, trading inflation for wage equality. Unless the central bank accommodates these demands,
unemployment rises as well.

discord, rather than any positive synergy. One might suppose that conservative parties would
take a hard-line on union wage demands, but if the market is sufficient to restrain atomized
unions, there may be little for the right to do. Instead, by combining Calmfors-Driffill and
Lange-Garrett, we arrive at the conclusion that the left, as a credible provider of social policy
bargains, can always lower unemployment, but it does so most in moderately centralized labor
markets, where unions wage temptations are greatest.
This paper focuses on the conditions for successful social policy bargains and their effects on
economic performance. Although I do not pursue the details of the mechanism here, investigation should probably begin with the social pacts among governments, unions, and employers
that have spread across Europe in the last fifteen years (Pochet and Fajertag 2000). These
pacts typically center on trades of wage restraint and labor market reform for social policy
compensation (which may include increased education and training spending, more public sector employment, lower taxes and social contributions, and a greater role for unions in directing
social policy) (Hassel and Ebbinghaus 2000). A key puzzle in this literature is the prevalence
and success of social pacts in countries (like Ireland and Italy) lacking highly centralized wage
bargaining, traditionally the signal feature of corporatism (Rhodes 2001). But a link between
moderately centralized labor markets and social pacts is exactly what the theory presented here
implies, and bears a closer look in future work.

3 Wage Restraint For Sale: Formalizing the Argument

A formal version of the argument sharpens its implications considerably. To this end, I generalize Iversens model of union-central bank interaction to include a preliminary round of
party-union bargaining over wages. Implicitly or explicitly, the government offers larger social
policy benefits in exchange for lower wage demands by unions. The government, in fact, could
be seen as lobbying each union, offering contributions of social policy to influence the policy
of union wage demands. I therefore apply one of Grossman and Helpmans (2001, Ch. 7) models
of interest group bargaining to the unions wage decision. As expected, wage-policy bargains
lower unemployment most in moderately centralized labor markets, and have smaller effects
given either centralization or decentralization.

3.1 Sequence of play and economic assumptions

In the first stage of the game, the government and each union i set the level of social policy, P ,
and union wage demands, wi , according to the Nash Bargaining Solution. In the second stage,
the central bank sets the price level, , in response to the average wage, w, which results in the
equilibrium level of unemployment, U .
A few economic assumptions are needed to establish the model (these mirror Iversen [1999],
which should be consulted for further details). Assume the economy consists of n equally sized
unions, so the centralization of the labor market can be represented by c = 1/n. 3 To understand
3
Assuming that the number of unions proxies their concentration is empirically justified. Using data from
Ebbinghaus and Visser (2000) for the year 1995, I find a correlation of 0.69 between the (inverse of the) number of
unions and (the Herfindahl index of) union concentration in the dozen industrial democracies for which adequate
data exist. Instead of all unions, however, the correlation between the number of and concentration of bargaining
unitswhich in some countries may be sectoral confederations or peak associations rather than unions per seis

the incentives facing these unions in wage bargaining, we must consider the (out of equilibrium)
effect of wages on unemployment. Iversen shows that the change in unemployment for any given
union i is
Ui = wi (c2 c + 1) + wo c(1 c) ,
(1)
while the overall change in unemployment resulting from the wages of union i is
U = cwi + (1 c)wo ,

(2)

where wi is the wage demand of union i, and wo the wage rate set by other unions (see Model
Appendix for derivations). Since in equilibrium all unions set the same wage rate (i.e., w i = wo ),
the equilibrium change in unemployment is U = w , which will also be equal to zero (firms
cannot raise the wage bill any faster than prices).

3.2 Players
As in Iversens model, unions gain utility from real wages and low unemployment; however,
they now receive utility from social policy as well. The preference function of the ith union is
given by
i
h
(3)
VUi = P + (1 ) (wi ) (1 )Ui U

The parameter captures the weight given to social policy objectives, while measures the
relative importance of real wages and unemployment. Following Iversen, unions care about
unemployment both within the union (U i ) and economy-wide (U ). (To simplify exposition, I
depart from Iversen by excluding the possibility that unions act to reduce wage inequality.)
The monetary authority, on the other hand, cares only about economic outcomes. Its
preference function is
2
VM = 2 (1 )U
(4)
Thus captures the conservatism of the monetary authority in terms of its preference for
inflation versus unemployment.
Finally, the government has three objectivesto minimize the cost of social policy while
producing low inflation and low unemploymenthence
h
i
VG = P (1 ) (1 )U ,
(5)
where captures the budgetary conservatism of the government (the rate at which extra spending reduces its utility), and measures the economic conservatism of the government (its concern for inflation relative to unemployment). 4

most relevant. Using Iversens (1999) assessment of the primary bargaining level in each country, this correlation
is 0.88.
4
I assume government utility is linear in inflation and unemployment to simplify exposition, though these
terms could be made quadratic (mirroring the central banks preferences) without changing the thrust of the
argument.

3.3 Equilibirium
I solve the game by backwards induction. I find that unions and government anticipate the
monetary authority will set the price level subject to the following maximization condition,
expressed in terms of a given unions wage choice 5 :
i
h
(6)
(wi ) = (1 ) U + cwi + (1 c)wo

The central bank will accommodate wage increases through prices only to the extent it is
sensitive to the unemployment that would result from nonaccommodationif the central bank
is hawkish on inflation (high ), it holds a tighter line on inflation and allows unemployment to
rise.
In the first stage, I assume the government and labor unions reach the Nash Bargaining
Solution. That is, they agree on the wage and social policy that will maximize the geometric
average of what each would gain under the agreement relative to the status quo without the
agreement, given the monetary authoritys best move in the second stage. Thus the government
and unions choose (wi , P ) to maximize:
h
i
h
i
ln VUi (wi , P ) VUi (w
i , 0) + (1 + ) ln VG (wi , P ) VG (w
i , 0)
(7)

where is a constant reflecting the bargaining power of union i relative to the government, and
w
i denotes the wage that would prevail absent social policy payoffs. 6
I show in the Model Appendix that solving this maximization problem leads unions to
demand wages equal to Iversens equilibrium, lowered in exchange for social policy gains. In
turn, the equilibrium level of unemployment consists of two terms:
U=

1
(1 c + c)
+
c( )
2
(1 )(c 2c + 2c + 1) 1 1

(8)

which is simply the equilibrium level under Iversens model (the first term, which I denote U a ),
reduced by social policy bargains (the second term, denoted U b ). Since no mechanismneither
social policy bargains nor central bank threatscan lower unemployment below zero, I impose
the additional restriction that U = max(0, U ).
If unions do not care about policy ( = 0), if the government does not care about the
economy ( = 1), or if the central bank and government are both ultra-liberal on inflation
( = = 0), then no bargain occurs and Iversens equilibrium holds as a special case. But in
all other cases, social policy bargains reduce unemployment by an amount that is increasing
in centralization (c), the inflation-hawkishness of the central bank () and government (),
and unions desire for policy (), but declining in the governments fiscal conservativism ( ).
Moreover, the effect of the central banks inflation preferences is always stronger than that of
government preferences. (See Model Appendix for proofs). In the next section, I illustrate
visually the relative force and interactions of these relationships.
5
Once the second stage is reached, the central bank responds to the average wage, w, which in equilibrium is
equal to wi as all unions are identical by assumption. Thus (6) simplifies to (w) = (1 )(U + w).
6
That is, w
i is the equilibrium of Iversens model, sans inequality motives.

3.4 Hypotheses
First, I take positions in the Unions and Central Banks debate; then I offer expectations about
the added impact of partisan governments. Table 1 summarizes how my hypotheses compare
to past studies.
Regarding the interaction of unions and central banks, there is substantial agreement that
at least in moderately centralized labor markets, non-accommodating central banks lower unemployment. But where wage bargaining centralization is high or low, monetary effects remain
unclear. Iversens argument that pressure to maintain equality in centralized labor markets
will clash with strict monetary regimes makes sense, but is hard to test conclusively given the
paucity of these arrangements. On the other hand, while standard (rational expectations) theory dismisses the possibility that monetary policy will have real effects in decentralized labor
markets, Franzese persuasively argues that hawkish central banks in (mostly) decentralized
labor markets will drive up unemployment to check inflation pressures from unions that cannot
be credibly threatened. In sum, I expect monetary non-accommodation to produce higher unemployment in decentralized economies, lower unemployment in moderately centralized labor
markets, and (perhaps) higher unemployment in highly centralized markets.
With the solution to wage restraint for sale in hand, we are ready to frame three additional
hypotheses. Figure 2 maps expected unemployment at various levels of centralization given any
combination of (high or low) monetary accommodation and (present or absent) social policy
bargaining. In the first row of plots, solid lines show the equilibrium for Iversens model of
union-central bank interaction where unions care about wages and unemployment only; dotted
lines add social policy bargains for wage restraint. Setting aside differences between monetary
regimes and focusing first on the reduction in unemployment under social policy bargains
(highlighted in the second row of plots), the model confirms that bargains most effectively reduce
unemployment at moderate levels of centralization. On the other hand, bargains are negligible
at low levels of centralization, since in this case, the connection between a given unions behavior
and the average wage is weak. And at high levels of centralization, peak associations self-restrain
to avoid the inflationary consequences of high wage demands, minimizing (though not entirely
eliminating) the scope of further gains from bargains with the government.
Now, compare across monetary regimes. The examples in Figure 2 demonstrate that social
policy bargains will reduce unemployment more (and reach maximum impact at lower levels
of centralization) the more non-accommodating the central bank. A systematic survey across
parameter values shows this is the case. I plot in Figure 3 the total unemployment reduction
across the range of centralization for all possible combinations of central bank and government inflation preferences.7 The left panel of this figure shows that regardless of government
inflation preferences (), more restrictive central banks (those with higher ) produce larger
employment gains from social policy bargains (i.e., the shading grows darker to the right of
the plot). And though government inflation preferences also affect unemployment, the benefits
of government economic conservatism turn out to be trivial, especially if the central bank is
already conservative.
R1
R min(c,1)
The total unemployment reduction is the area between the curves in Figure 2, 0 Ua dc 0
Ub dc (
c
denotes the level of centralization at which social policy bargains reduce unemployment to zero). And since c
ranges over [0, 1], the total unemployment reduction happens to equal the average unemployment reduction.
7

10

Table 1: Expected effects of parties, unions, and central banks on unemployment

11
Varies with
CBI
Varies with
CBI
Varies with
Party & CBI

Hall-Franzese

Proposed 3-way
Interaction

Varies with
Party

Firm or peak
bargaining best

Iversen

Synthetic Models
Lange-Garrett

Central Bank Indep.

(GMT; Barro-Gordon)

Partisan Cycles
(Alesina)

Building Blocks
Corporatism
(Calmfors-Driffil)

Effect of
Labor Market
Institutions

Temporary decrease from RPC

Perm.
Decrease

Weak perm. Big perm. Weak perm.

decrease
decrease
decrease
in each case combined with

No
Effect

Perm.
Increase

Temporary decrease only

Effect of Left Government

given wage bargaining at
Firm
Industry
Peak

Lower
Unemp.

Lower
Unemp.

Lower
Unemp.

Higher
Unemp.

Higher
Lower
Higher
Unemp. Unemp.
Unemp.
Augments permanent
partisan cycle
Suppresses temp. partisan cycle

Higher
Unemp.

No
Effect

No effect

Moderates partisan cycle

Effect of Central Bank Independence

given wage bargaining at
Firm
Industry
Peak

Accommodating CB
( = 0.55)

Nonaccommodating CB
( = 0.7)

1.2

Unemployment
(U)

no bargain

1.0

0.8

1.2

no bargain

1.0
0.8

0.6

0.6

bargain

0.4

0.4

0.2

0.2

0.0

bargain

0.0
0.0

0.2

0.4

0.6

0.8

1.0

0.0

0.2

0.4

Centralization (c)

1.0

0.6

0.8

1.0

1.4

1.2

1.2

1.0

1.0

0.8

0.8

0.6

0.6

0.4

0.4

0.2
0.0

0.8

1.4

Reduction in
Unemployment
(U)

0.6

0.2

~
c = 0.77

0.0

0.2

0.4

0.6

0.8

1.0

0.0

~
c = 0.47

0.0

0.2

0.4

Figure 2: Social Policy Bargains Lower Unemployment Most Given Moderately Centralized
Labor Markets and Hawkish Monetary Authorities. In the top row, the unbargained cases (solid
lines) are from Figure 1 and represent unemployment under Iversens model (or, equivalently,
the present model with = 0 or = 1, and = 0.5). The bargained cases (dashed lines)
assume unions and governments care equally about inflation, unemployment, and social policy
( = = 0.5, = = 0.33). The bottom row shows the difference, which is the reduction in
unemployment under social policy bargains.
These results are intuitive, though not obvious implications of the model. When the central
bank is non-accommodating, unions and governments anticipate harsher consequences of failing
to reach an agreement, since wage militancy will be offset with higher unemployment. Acting
alone, the unions are at least partially compensated by their higher real wages. But since the
government cares about unemployment and inflation, and not unions wages per se, it will offer a
bargain substituting social policy for wages, averting unemployment and inflation, and leaving
both sides better off.8 The central banks preferences are crucial, because the necessity and
scope of the bargain is a function of the central banks threat to hold the line on inflation. On
the other hand, since both unemployment and inflation will be lower when unions practice wage
restraint, it does not matter much which economic indicator is paramount for the government.
Thus far, I have established two propositions: social policy bargains (tend to be) hump8
Even if the governments preference function included real wages, it would care not for union is real wages
but the average real wage in the economy, so like an encompassing union, the government would favor restraint.

12

Gov is budget liberal

(Low )
Gov conserv
on vs. U

Gov is budget conservative

(High )

1.0

1.0

0.8

0.8

0.6

peaked

0.4

unpeaked

0.0

0.2

CB liberal

Typical

Left Gov

Gov liberal 0.2

on vs. U

0.0

0.4

0.6

0.8

Typical
Right Gov

0.6
peaked

0.4
unpeaked

0.2
0.0

1.0

0.0

0.2

0.4

0.6

0.8

1.0

CB conserv

Darker shading bigger reduction in unemployment:

0.2

0.4

0.6

Figure 3: Policy-for-wage-restraint bargains are strengthened by government willingness to spend

and central bank non-accommodation. Shading indicates total unemployment reduction across
all levels of centralization for the given scenario. Social bargains in the region marked peaked
reach their unemployment reduction maxima in moderately centralized economies, and in the
region marked unpeaked at c = 1. The left plot assumes = 0.25; the right assumes = 0.75.
Both plots assume unions care equally about inflation, unemployment, and social policy ( =
0.5, = 0.33).

shaped in centralization, and growing in central bank non-accommodation. What remains to be

shown is that they are partisan. While the role of government inflation preferences is trivial, the
impact of budget conservatism is not. Comparing the two plots in Figure 3, it is clear that when
the government is more liberal on spending (left plot) social-policy-for-wage-restraint bargains
are far deeper, and are peaked over the entire range of likely central banks (e.g., those that care
about inflation at least as much as unemployment). In contrast, a government that strongly
resists spending on social policy will produce very small unemployment reductions (unless the
central bank is ultra-conservative). For any sensible ranges of the model parameters, then,
social policy bargains will significantly reduce unemployment only when left-wing governments
are in office.9 The upshot is a permanent, labor-market contingent partisan cycle.
The permanent partisan cycle interacts with central bank independence in opposite fashion to Alesinas temporary partisan cycles: labor-market-contingent cycles are augmented by
higher CBI, while temporary cycles should be reduced. 10 Empirical efforts to test for the in9

There is another reason to think these cycles will be strongly associated with left government. Government
promises of social policy compensation must be credible to spur unions to sign restrained labor contracts. Since
the left typically relies on union members for electoral support, it has a strong incentive to keep its word, but
the right, needing neither labor votes nor particularly eager to spend on social programs, may be less credible to
unions, making policy-for-wage restraint bargains harder to achieve, or at least less extensive. In other words,
when the right is in power, unions will take the money and run.
10
In passing, note that this is a counter-example to Franzeses (1999) claim that CBI reduces the magnitude of

13

stitutional contours of partisan cycles must therefore take both types of cycles into account, to
avoid mistaking one institutional interaction for the other. For example, if the labor-market
conditional partisan cycle is more important than the temporary rational partisan cycle, but
we tested only for the latter and its interaction with CBI, we might find that temporary cycles
were stronger in high CBI countries, rather than weaker. To avoid misleading results, I test for
both cycles simultaneously.

4 Testing competing views of the politics of performance

I test the hypotheses using data from 15 industrial democracies for 1975 to 1998 (see Data
Appendix for sources and coding). The countries and period included are those with available
data, which is limited mainly by the labor market centralization variable. Unlike most empirical
work in the field, however, the data on labor markets, central banks, and parties used here
display meaningful variation over time as well as across countries, a key advantage for sorting
out interactive institutional effects. The analysis proceeds as follows. As a first step, I present
basic models testing Alesinas rational partisan cycle and Iversens model of strategic interaction
between unions and central banks. Then I test a synthetic model including interactions among
three institutions: partisan governments, unions, and central banks. Throughout, I employ
graphical presentations of model estimates to make results tangible and comparable across
models.

4.1 Data and Methods

The dependent variable is quarterly unemployment. Following Alesina, Roubini, and Cohen
(1997), unemployment in country i and time t is measured as the difference between country
is unemployment and the G7 average for that period, excluding country i. To further mitigate
autocorrelation, two lags of the dependent variable are included in all specifications. Another
concern is heteroskedasticity among countries, which residual plots show to be present, though
minor. Thus, following Beck and Katz (1995), the model is estimated by least squares with
panel-corrected standard errors. 11 Finally, country fixed effects are added to reduce omitted
variable bias.
For complex interactive specifications, tables of regression results leave most substantive
questions unanswered (King, Tomz, and Wittenberg 2000, Cam and Franzese 2003). Moreover,
it is hard to tell at a glance when interactive effects are significant because more than one
standard error is involved. A simple solution is to show how the expected value of the dependent
variable changes in response to hypothetical shifts in an explanatory variable, holding other
variables constant. For example, we can quantify the effect of a change in CBI (or the party
in government, or both) for any level of centralization of wage bargaining, and establish a
confidence interval for that effect.
Another interpretive pitfall is the time series nature of the model. Because the data are
quarterly time series, coefficients convey per quarter effects. But the real quantity of interest
all other institutional determinants of nominal outcomes. In this case credible non-accommodation spurs more
extensive wage restraint through government policy incentives precisely because the government does not control
monetary policy.
11
I use Franzeses (1996) Gauss procedure to calculate PCSEs for non-rectangular data.

14

is the cumulative effects of institutional change over longer periods of time, since political
institutions tend to persist for years. Fortunately, using the estimated model, we can calculate
first differences and their confidence intervals for any period we like. To calculate the effect of
an institutional change in period 1 that persists through period T , I first calculate the period 1
expected value and its confidence interval; then use this point estimate and interval as the lag
in calculating period 2, and so on until period T . To obtain the first difference, I subtract the
expected unemployment levels for period 0, when the old institutions held sway.
Thus, I need to make some assumption about the ex ante values of the dependent variable
before period 0. One reasonable approach is to set these initial lags to the level at which
unemployment would have converged if the ex ante institutions had been in place indefinitely. 12
Since the model is a second-order difference equation with lag coefficients 1 + 2 < 1, the
convergent level of unemployment under fixed values of the independent variables, X i , is13
U\
DIF F it

Xi
as t
1 1 2

(9)

Beside being useful for first difference calculations, the expected value of the convergent unemployment rate portrays the ultimate tendency of a particular institutional configuration.

4.2 Variables
Challenging Party Electoral Victory within the last 6 quarters (CV6 ): As noted by
Alesina, Roubini, and Cohen, challenger victories are likely to be a decent proxy for surprising
elections. I follow their lead in coding a variable, CV6 it which takes on the value 1 for the
six quarters following a left-wing challenger victory, 1 for the six quarters after a right-wing
challenger win, and 0 otherwise. I expect this variable to have a positive effect on unemployment (i.e., right-victory temporarily raises unemployment). Experimentation with various lag
structures and lengths of partisan effects reveals that the second lag of this variable, CV6 i,t2 ,
best captures the temporary partisan cycle.
Partisanship of Current Administration (ADM ): To test for permanent partisan effects,
12

As two of our institutions, CWB and CBI, tend to remain relatively constant for many years at a time,
the convergent unemployment rate seems like a good lag. But for parties that cycle in and out of office over
the years, this assumption is less than ideal. However, it does provide a useful baseline from which to consider
alternative scenarios of partisan history. Thus, readers interested in the effect of a change in partisanship
where recent history includes both left and right governments might suppose that the unemployment in period
0 reflects some linear combination of the tendencies of each party, given the institutional setting: UDIFF 0 =
UDIFF Left +(1)UDIFF Right , given 0 1. Since the calculated first difference for a right electoral victory
reflect the case where = 1 at time 0 (i.e., we assume prior unemployment converged to the left tendency), call
these results t UDIFF t |( = 1). It follows that t UDIFF t | = t UDIFF t |( = 1). Thus, for example, if
the initial level of unemployment lies halfway between the left and right tendencies at the start of a right-wing
government, the appropriate first difference estimates are exactly half those shown.
13
Unemployment, even as a deviation from the G7 average, is clearly a long-memoried process (i.e., it contains
a near-unit root), raising the risk of spurious regression. This will not be a problem so long as the variables in
the model are cointegrated. We can make use of the fact that the lagged dependent variable specification can
be re-arranged to an error correction model to perform a cointegration test, as recommended by De Boef and
Granato (1999). In the ECM context, variables are cointegrated if the adjustment parameter (here, 1 1 2 )
is different from zero. For the models examined in this paper, 1 1 2 is significantly different from zero at
the 0.001 level.

15

I use a simple coding of whether the government is right-wing (1) or left-wing (-1), which I
updated from Alesina, Roubini, and Cohen. I have no expectation regarding ADM except in
interaction with other variables.
Centralization of wage bargaining (C): Coded by Iversen, this variable captures the weight
given to each level of bargaining and the percentage of workers covered at each level (See Data
Appendix for further details). Centralization ranges from 0 to 1 in theory, and is observed to
vary between 0.01 and 0.43.
Central Bank Independence/Monetary Fixity (I): Devised by Iversen (1998a), this
measure of monetary non-accommodation comprises an institutional measure of central bank
independence, varying by decade, and a behavioral measure of restrictiveness, exchange rate
stability. While the former varies too little to capture the true variation in monetary restrictiveness over time, the latter varies too much, and is sensitive to short-range speculative trends.
Averaging them thus strikes the best balance possible with available data, though a better measure of central bank conservatism would strengthen the results. This variable is also scaled (0,1).
Export Market Growth (EXMAR):
Following Iversen, I control for shocks impacting a
countrys export market, using OECD data on the growth in each countrys export markets.

4.3 Results
Before proceeding to new hypotheses, it is worth confirming some of the building blocks of
the synthetic model. I present raw regression results for each of these models in Table 2 for
comparison with past studies. Readers interested in the present study need not decipher Table
2, and instead can focus on the graphics that follow.
I first test Alesinas rational party theory, for which I collected data over the period 1960Q1
to 1998Q2. The model to be fitted is
UDIFF it = 1 UDIFF i,t1 + 2 UDIFF i,t2 + CV6 i,t2 + i + it

(10)

where i is a country fixed effect and it is a normally distributed disturbance. The results
(Table 2, column 1) echo Alesina, Roubini, and Cohen: a change of government from left to right
temporarily raises unemployment (and vice versa for right-to-left transitions). First differences
show this effect is significant but small. Even at the point of maximum accumulated impact,
ten quarters after the election, temporary partisan cycles add or subtract only .52 percentage
points of unemployment from the pre-election rate, with a 90 percent confidence interval of .28
to .75.
I test Iversens theory of the interaction between central banks and unions using Iversens
own specification, now applied to quarterly data (rather than four-year averages). Iversens

16

Variable
Cit

Prediction
+

Cit2

Iit

Cit Iit

Cit2 Iit

CV 6i,t2

ADMit

ADMit Cit

ADMit Cit2

ADMit Cit Iit

ADMit Cit2 Iit

EXMARit

UDIFFi,t1
UDIFFi,t1
Fixed effects
N
s.e.r.

Unions and
Central Banks
2
3.02 ***
(1.14)
5.39 **
(2.74)
0.635 **
(0.301)
8.44 **
(3.39)
14.63 *
(7.79)

Parties
1

0.065 ***
(0.018)

1.29 ***
(0.03)
0.302 ***
(0.031)
x
1926
0.346

0.007 **
(0.003)
1.29 ***
(0.04)
0.305 ***
(0.038)
x
1311
0.355

Parties, Unions,
and Central Banks
3
4
3.76 ***
3.86 ***
(1.17)
(1.18)
7.51 ***
7.53 ***
(2.86)
(2.89)
0.636 **
0.685 **
(0.302)
(0.304)
10.2 ***
11.3 ***
(3.39)
(3.55)
19.0 **
21.0 ***
(7.78)
(8.07)
0.049 **
0.032 **
(0.023)
(0.020)
0.035 *
0.057
(0.021)
(0.720)
1.20 ***
0.113
(0.342)
(2.19)
3.23 ***
3.15
(1.00)
(1.62)
3.15 *
(1.62)
9.29 *
(4.96)
0.007 ***
0.007 ***
(0.003)
(0.003)
1.27 ***
1.27 ***
(0.04)
(0.04)
0.292 ***
0.290 ***
(0.038)
(0.038)
x
x
1311
1311
0.345
0.345

Table 2: Institutional determinants of unemployment in fifteen industrial democracies, 1975

1998. Least squares regression coefficients with panel-corrected standard errors (Beck and Katz
1995, Franzese 1996) in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.

17

Levels

First Difference

25

Unemployment 20

Low CBI

15
10

High CBI

0
5

5 years after
increasing CBI

0.0

0.1

0.2

0.3

0.4

Centralization of Wage Bargaining

0.0

0.1

0.2

0.3

0.4

Centralization of Wage Bargaining

Figure 4: Iversens model of central banks and unions: long- and medium-run results. In the left
panel, solid lines reflect the limit to which an economy would converge given fixed institutions.
Black lines assume accommodating central banks (1.5 s.d. below the mean level of I), while
gray lines assume non-accommodating central banks (1.5 s.d. above the mean). The right panel
shows the expected change in unemployment five years after an increase from low to high nonaccommodation. In all plots, dashed lines show 90 percent confidence intervals. All predictions
and confidence intervals are based on Model 3, with partisanship and other controls held at
their mean values.

theory is intricate, and requires a fittingly complex specification (expectations below) 14 :

UDIFF it = 1 UDIFF i,t1 + 2 UDIFF i,t2
+ 1 Cit + 2 Cit2 + 3 Iit + 4 Cit Iit + 5 Cit2 Iit + 6 Exmar it + i + it (11)
+

By including Cit and Cit2 , I test for the presence of a Calmfors-Driffill hump-shaped relation
between centralization and unemployment, which I allow to be flipped in the presence of high
CBI by including interactions with I it . Finally, by including an uninteracted I it , I allow CBI
to increase (or decrease) unemployment in the decentralized case, thereby shifting the point of
monetary neutrality to the right (or left) on the centralization axis. As Table 2 shows, testing
Iversens theory on more finely grained economic data allows us to estimate his parameters more
precisely. All of Iversens expectations are now met (while in his original test of the model, 1
was, contrary to expectation, insignificant), adding to our confidence that the Calmfors-Driffill
relation is inverted by monetary non-accommodation. Notably, 3 is now positive and significant, supporting Hall and Franzeses view that CBI can raise unemployment in decentralized
economies.
14

To understand Iversens specification, recall that it tests whether the Calmfors-Driffill hump is inverted
for sufficiently high I. A model testing just Calmfors-Diffill would include (omitting subscripts) 1 C + 2 C 2 ,
anticipating 1 > 0 and 2 < 0. But if instead we include (1 C + 2 C 2 )( I), > 0, then for I < ,
the specification will produce a hump, and for I > , the hump will be inverted into a U. Multiplying and
reparameterizing yields the specification in the text.

18

Right Government

Left Government

Unemployment

30

30

25

25

20

20

15

15

Low CBI

10

10

0.0

0.1

0.2

High CBI

High CBI

5
10

Low CBI

5
0.3

0.4

Centralization of Wage Bargaining

10

0.0

0.1

0.2

0.3

0.4

Centralization of Wage Bargaining

Figure 5: Long term results from the three-way model of central banks, unions, and partisan
governments. Solid lines reflect the limit to which an economy would converge given fixed
institutions and government, with left-wing government in power in the left plot, and conservative government in the right plot. Black lines assume accommodating central banks (1.5
s.d. below the mean level of I), while gray lines assume non-accommodating central banks
(1.5 s.d. above the mean). Dashed lines are 90 percent confidence intervals. Predictions and
confidence intervals are calculated using Model 3, with controls held at their mean values.
We can best understand these results through expected values and first differences, which
combine the various interactions to show how institutional effects accumulate over time. One
way to summarize these results is to calculate the level to which unemployment would converge
given fixed CWB and CBI. Figure 4 (left panel) shows this convergent unemployment rate over
the observed range of centralization, given either high CBI/monetary fixity (1.5 standard deviations above the mean observed level) or low CBI/monetary fixity (1.5 standard deviations below
the mean), holding other regressors at their means. 15 For moderately centralized economies,
monetary non-accommodation offers large and significant long-term unemployment reduction.
Only at the highest observed levels of centralization does this benefit fade. Meanwhile, for
decentralized labor markets, high CBI imposes significant unemployment costs.
Figure 4 (right panel) focuses on this possibility via five-year first differences, showing the
expected change in unemployment after reforms to raise central bank independence. After
five years, a decentralized economy could expect a mean increase in unemployment of about 3
percentage points, though the wide confidence interval cautions that the true value could be
closer to zero or as high as 6 points. For moderately centralized economies, the unemployment
reduction induced by monetary non-accommodation is of similar, if not greater, magnitude,
and the 90 percent confidence interval narrower (indeed, at the point of maximum benefit, CBI
lowers unemployment by 3.9 points, give or take 1.7 points).
We are now ready to combine partisan, labor market, and central bank variables in a single
model. To test for labor-market contingent partisan cycles, I add three terms to Model 2:
ADM it , ADM it Cit , and ADM it Cit2 . Since I expect left parties to lower unemployment
15

Since the outcome of interest is the unemployment level, while the dependent variable is the difference
between the unemployment level and the G7 mean, I add the G7 mean (which was 6.72 percent, after adjusting
for excluded cases) to the results in Figures 4 and 6.

19

U
under
Left

U
under
Right

+1 year

2
+5 years

4
6

0.0

0.1

0.2

0.3

0.4

Centralization of Wage Bargaining

Figure 6: First differences from the three-way model of central banks, unions, and partisan
governments. The left axis shows the simulated effect of a left-wing electoral victory after a
long period of rule by the right. Black lines show the cumulative change in unemployment one
year after the election, while gray lines depict the cumulative change in unemployment five year
after the election. Dashed lines are 90 percent confidence intervals. Predictions are calculated
from Model 3, iterated through twenty periods, with temporary partisan variables changing
appropriately over the five year period.
the most where centralization is moderate, ADM it Cit should be positive, and ADM it Cit2
negative. I also add Alesinas temporary cycle variable, to avoid confounding temporary cycles
with permanent, labor-market-contingent partisan effects. The estimated model, reported in
Table 2 (column 3), meets our expectations regarding labor-market-contingent partisan cycles,
which take place alongside the temporary partisan cycle. Iversens variables remain robust to
the inclusion of partisan variables and interactionsindeed, his regressors are estimated more
precisely than everand CBI still raises unemployment in decentralized labor markets. 16
Once again, graphs of expected values show the interactive effects of parties, unions, and
central banks most clearly. Figure 5 shows the long-run tendencies of unemployment under
continuous rule by either the left or the right given either high or low CBI and any level of
centralization. Partisan effects are visibly greatest at moderate levels of centralization, with
unemployment lowered by the left and raised by the right. Comparison of the left and right
panels evokes the predictions of the formal model of wage/policy bargaining, which held that a
government able to credibly offer policy rewards for wage restraint would lower unemployment
most where wage bargaining was moderately centralized.
Figure 5 shows long-term expectations, but partisan cycle theory focuses on short and
medium run effects following elections. Cumulative first differences are an ideal way to show
the combined effect of temporary and permanent partisan cycles in the years following a change
16

To test robustness, I re-estimated model 3 excluding each country in turn. Coefficients of variables cap2
turing the labor-market-contingent partisan cycle (ADM it Cit , ADM it Cit
) proved quite robust, remaining
approximately the same size over all 15 reduced-sample regressions and always significant at the 0.05 level. The
2
2
four terms crucial to Iversens hypotheses ( Cit , Cit
, Cit Iit , and Cit
Iit ) are robust to the exclusion of any
country other than France, again at the .05 level. The additive impact of CBI is sensitive to the exclusion of
France and Belgium (though the latter only barely misses significance at the 0.1 level), and Alesinas measure
of temporary cycles is slightly sensitive to the exclusion of Denmark.

20

U
under
Left

Low CBI

2
High CBI

4
6

U
under
Right

(Both scenarios are +3 years)

0.0

0.1

0.2

0.3

0.4

Centralization of Wage Bargaining

Figure 7: First differences from the three-way model of central banks, unions, and partisan
governments, fully interactive specification. Solid lines show the change in unemployment three
years after a left-wing government replaces a long-standing right-wing administration, according
to the monetary regime. Black liness assume accommodating central banks (1.5 s.d. below the
mean), while gray lines reflect non-accommodating central banks (1.5 s.d. above the mean).
Dashed lines are 90 percent confidence intervals. Predictions are calculated from Model 4,
iterated through twelve periods, with temporary partisan variables changing appropriately over
the three year period.
in government. Moreover, statistical tests validate the required iteration of the model through
several years.17 Given our hypotheses, one expects unemployment to fall in all economies
immediately after a left-wing victory. Over time, this effect intensifies in moderately centralized
economies and vanishes in labor markets closer to the extremes (with predictions reversed for
a conservative victory). Figure 6 reveals essentially this pattern. One year after the left takes
over, unemployment falls slightly (generally less than one point) in most economies. The
unemployment benefit of left-wing government in moderately centralized economies grows to
as much as 3.4 points (plus or minus 1.4) after five years, while no significant effect persists
in atomized or highly centralized labor markets. Labor-market-contingent permanent cycles
swamp temporary cycles, even in the year or two following the election.
Our final hypothesis, also drawn from the wage restraint for sale model, is that the
size of labor market-contingent cycles should be directly proportional to monetary nonaccommodation. That is, the more conservative and independent the central bank, the larger
the reduction in unemployment produced by left-wing government of a moderately centralized
labor market. Confirming this empirical implication will add a measure of confidence in the
17

Though the confidence intervals in Figures 6 and 7 reflect uncertainty accumulated over several periods, they
appropriately cover the observed data. By definition, observed unemployment should lie inside the q percent
confidence interval q percent of the time. To confirm that these confidence intervals have good coverage, I
calculated fitted values and confidence intervals for every one- and five-year period observed in the data (that is,
I predicted unemployment over the period using only the explanatory variables and initial unemployment, for
a total of 1244 one-year predictions and 884 five-year predictions). The coverage of the confidence intervals is
quite reasonable. The actual level of unemployment after five years falls inside the 50 percent confidence interval
55.5 percent of the time after one year, and 51.4 percent of the time after five years, and inside the 90 percent
confidence interval 91.9 and 91.7 percent of the time, respectively. In sum, the first differences in Figures 6 and
7 appear to reliably reflect the data.

21

theoretical model. Hence, I add two more interaction terms: ADM it Cit Iit , which should be
positive, and ADM it Cit2 Iit , which should be negative. These terms test for an interaction
between the central banks stance and the permanent partisan cycle. I also add an interaction
between temporary partisan cycles and CBI/monetary fixity, which turns out to be approximately zero. This term is dropped from the final regression, and its inclusion or exclusion does
not affect permanent partisan effects. 18 The raw regression results appear in the last column
of Table 2, and meet our expectations.
As before, first differences capture the cumulative effects of a change in the governing party
(in this case, after three years) for either high or low CBI/monetary fixity. We have a clear
predictionthe results in Figure 7 should match the pattern predicted in Figures 2 and 3.
With the possible exception of highly centralized economies (where our confidence is low), the
match between prediction and result is remarkably close. Labor-market-contingent partisan
cycles are stronger where central banks are less accommodating, and maintain their humpshaped relationship with centralization of the labor market. Indeed, as non-accommodation
increases, the peak of the partisan cycle moves to lower levels of centralization, as anticipated
by the model. Overall, the partisanship of government, restrictiveness of the central bank, and
centralization of wage bargaining interact as expected in shaping unemployment outcomes.

5 Conclusions
Interpreting the role partisan governments play in labor markets, I emphasize the possibility of
bargains between labor and left-wing governments that trade policy for wage restraint, lowering
unemployment. I argue that partisan governments impact on unemployment matters most in
moderately centralized labor markets, rather than in more extreme cases, as the literature
has tended to assert. This mirrors earlier findings that monetary non-accommodation is most
effective in reducing unemployment in such labor marketsindeed, I show theoretically and
empirically that left parties and conservative central banks may be strongly complementary in
just this case.
At a mimimum, the model and findings presented here should persuade readers that political economic institutions have deeply interactive effects on economic performance. Further
research should consider exactly how partisan governments, unions, and central banks interact,
and how that interaction might change over time and with repeated bargaining. Clearly, the
policy mechanisms governments use to encourage union restraint need to be isolated, though I
suspect social pacts are the place to begin the search. But extensions of this paper might also go
beyond the bargaining framework to recognize the multiple avenues by which governments can
affect monetary policy, labor market organization, and the interaction of these institutions in
18

Since delegating monetary policy to a non-accommodating central bank should lower uncertainty about
future economic policy, regardless of the party in government, the interaction term CV6 i,t2 Iit should carry
a negative coefficient, counteracting the temporary partisan cycle. However, this is not the case. In a variety
of specifications, this term is usually positive and not significant, and its inclusion tends to reduce CV6 i,t2
to near zero. This partly reflects omitted variable bias from the interaction of CBI and the labor-market
contingent partisan cycle, but even controlling for this (by including all the regressors in Model 4), the coefficient
of CV6 i,t2 Iit is approximately zero. Though the small size of temporary partisan cycles hinders empirical
investigation of their institutional contours, this is not encouraging news for rational partisan theory, and supports
Drazens view (2000) that temporary cycles are not monetary in origin.

22

the wage determination process. After all, governments regulate unions and employers, appoint
central bankers, and codify the degree of central bank independence. In short, the literature
developing around the proposition that labor markets and central banks interact should add
an explicit role for the government itself.

23

Model Appendix
Part I. Model Assumptions
To derive (1) and (2), Iversen decomposes the effects of wage-setting by union i into a
relative price effect (ir ) and an aggregate price effect (ia ). According to Calmfors and Driffill,
a unions ability to pass on wage increases through prices is proportional to its size (since larger
unions imply poorer substitution among products from different bargaining areas), hence (to
choose a simple functional form) ir = cwi . Analogously, the relative price effect for all other
unions can be written or = cwo . The aggregate price effect of union is wage demand is also
proportional to its size; hence ia = c2 wi , while the aggregate effect of all other unions wage
demands is oa = c(1 c)wo .
Assuming that increases in real wages lower profits and raise unemployment, Iversen captures the change in unemployment within union i as the sum of the real increase in wages across
the economy and the real increase in wages within union i, or
Ui = (ia + oa ) + (wi ir ),

(12)

which simplifies to (1) in the text. Analogously, the increase in aggregate unemployment is the
weighted average
Ui = (ia + oa ) + c(wi ir ) + (1 c)(wo or ),

(13)

which simplifies to (2) in the text (Iversen, 1999).

Part II. Equilibrium
To solve the bargaining problem, it will help to isolate the non-social policy components
of the players preferences. Hence, we rewrite union preferences as V Ui = WUi (wi ) + (1 )P ,
where WUi = (wi ) (1 )Ui U . As in Iversen, WUi can be written as a function of the
wage wi by substituting the disequillibrium conditions U i + Ui for Ui and U + U for U .
I rewrite government preferences in similar fashion as V G = WG (wi ) P , again substituting
U + U for U . We will also need the derivatives of these preferences functions:
WUi
= (1 c + c) (1 )(c2 2c + 2c 1)(w + U )
wi

and

WG
= c( ).
wi

We can now rewrite the Nash bargaining problem facing unions and governments as


h
i
h
i
max ln P + (1 ) WUi (wi ) WUi (w
i ) + (1 ) ln P + (1 ) WG (wi ) WG (w
i )
wi ,P

This yields two first order conditions:

(1 )(1 )WG /wi
(1 )WUi /wi
+
=0
P + (1 )[WUi (wi ) WUi (w
i )] P + (1 )[WG (wi ) WG (w
i )]

24

(14)


(1 )

=0
P + (1 )[WUi (wi ) WUi (w
i )] P + (1 )[WG (wi ) WG (w
i )]

(15)

The second condition establishes the increase in social policy the government offers unions:
i
i
h
1h
P =
WG (wi ) WG (w
i ) + (1 )
WUi (w
i ) WUi (wi )
1

(16)

The first condition defines the equilibrium wage demand made by a representative union i:
(1 )

WUi
WG
+ (1 )
=0
wi
wi

(17)

Note that the bargaining power parameter, , has fallen out of the equation.
To find equilibrium unemployment, I first substitute for W Ui /wi and WG /wi , and
solve for the equilibrium wage w (noting, of course, that in equilibrium, w i = wo = w):
w =

(1 c + c) (1 )U (c2 2c + 2c + 1) 1
+
c( )
(1 )(c2 2c + 2c + 1)
1

(18)

This is simply the equilibrium wage under Iversens model (the first term), adjusted for social
policy bargains (the second term). Finally, recalling that in equilibrium U = w = 0, I
solve for U , and obtain (8) from the main text.
Part III. Comparative Statics
To see that within the parameter space, social policy bargains either reduce unemployment
or have no effect, note that for all , (1 ) (0, 1], U b < 0 if and only if < 0, which
holds if either of or is positive. Otherwise, U b = 0.
Further, note that
Ub
1
=
c( )
(19)
c
1 1
which is negative given , (1 ), (0, 1]. Ceteris paribus, a reduction in U will be larger as
c increases, up to the zero unemployment constraint.
Next, note that
Ub
1
= c
(20)

1
also negative for all , (1 ), c, (0, 1]. Hence the governments distaste for inflation augments
unemployment reduction, up to the zero unemployment constraint.
Turning to the central banks preferences, observe that


Ub
1 ( 2)

(21)
=c

1
(1 )2
and, since 2 < 2 for all (0, 1], Ub / < 0 given , c, , (1 ) (0, 1]. Thus, the central
banks inflation aversion also strengthens unemployment reduction, up to the zero unemployment constraint.
To show that central bank preferences on inflation have greater marginal effect than government preferences, Ub / < Ub / must hold, which implies ( 2)/(1 ) 2 < . Since
25

the left-hand side is greatest when = 0, it suffices to show 2 > ( 1) 2 . This holds for all
[0, 1], completing the proof.

26

Data Appendix
Political Data:
Cit measures the centralization of wage bargaining, and is taken from Iversen (1998). C it =
P
1
2
2
, where wjt is the weight given each level of bargaining j (firm, industry, or peak
w
p
j jt ijt
level) at time t, and pijt is the percentage of workers covered by union i at level j. This variable
is the main constraint on the available time periods, since Iversen has coded it for 1973 to 1993,
and the other variables typically exist through 1998. However, for the periods it is available,
with a few notable exceptions, centralization mostly varies across countries rather than within
them. A reasonable guess of the missing centralization scores for 1994-1998 is to assume that
these figures did not change much from the 1993 levels. I ran the full analysis twice, first using
1993 values of centralization for later years, and then deleting observations after 1993Q4. The
regression and simulation results were nearly identical. In the interest of getting the most out
of the available data, I show results for the larger dataset.
Iit is a measure of monetary accommodation based on Iversen (1998a, 1998b). It contains two
components, CBI it and FIX it . CBI it is an average of (0,1) normalizations of three measures of
central bank independence (Bade and Parkin [1982], Grilli, Masciandaro, and Tabellini [1991],
and Cukierman, Webb, and Neyapti [1992], with the last being a decade-by-decade coding,
updated by Maxfield [1997] through 1994). FIX it is a measure of exchange rate fixity calculated
by the author in the same manner as Iversen (1998b). That is, FIX is the inverse of the squared
growth rate of the nominal effective exchange rate (NEER), such that higher values of FIX
imply a more fixed exchange rate. The NEER is provided by the IMF International Financial
Statistics. To calculate Iit , I normalize FIX it to (0,1) and average it with CBI it .
ADM it is a simple indicator of the partisan leaning of the administration, coded 1 when the
right is in office, and -1 when the left is in power. This variable is taken from Alesina, Roubini,
and Cohen (1997) for 1960Q1 to 1993Q4. Data for 1994-1998 were coded by the author from
the Europa World Yearbook (1998).
CVN it stands for Challenger Victory, and is coded 1 in the N quarters after the right wins as
a challenger, as -1 in the N quarters after the left wins as a challenger, and 0 otherwise. The
most effective variable for picking up temporary partisan cycles was CVN i,t2 , indicating the
six quarters after a challenger victory taken at two lags (or quarters 3 to 8). This variable is
borrowed from Alesina, Roubini, and Cohen (1997) for 1960Q1 to 1993Q4, and updated by the
author through 1998 using the Europa World Yearbook (1998).
Economic Data:
Exmar it measures the growth rate of country is export markets at time t. It has been reported
semi-annually since 1975 as part of the OECD Main Economic Indicators, available in the
OECD Statistical Compendium.
UDIFF it is the difference between the quarterly unemployment rate in country i at time t and

27

the weighted average quarterly unemployment rate in the seven largest economies at time t
(excluding country i as necessary). For every period, the seven largest economies were the
United States, Japan, Germany, France, the United Kingdom, Italy, and Canada. These seven
countries are weighted by their real quarterly GDP in dollars at time t. All GDP data are
taken from the IMF International Financial Statistics. These data are essentially the same
as those used in Alesina, Roubini, and Cohen (1997), but have been recollected and extended,
where possible, through 1998. The quarterly unemployment rate is taken from the OECD Main
Economic Indicators. Available series and years by country follow:
Country
Austria
Belgium
Canada
Denmark
Finland
France
Germany
Italy
Japan
Netherlands
Norway
Sweden
Switzerland
United Kingdom
United States

Series
Seasonally adjusted rate, civilian
Seasonally adjusted rate, insured
Seasonally adjusted rate
Seasonally adjusted rate
Seasonally adjusted rate
Unemployment as a percent of total civilian employment
Seasonally adjusted rate, civilian, West Germany only
Seasonally adjusted rate
Seasonally adjusted rate
Seasonally adjusted rate
Seasonally adjusted rate
Seasonally adjusted rate
Seasonally adjusted rate
Seasonally adjusted rate, civilian
Seasonally adjusted rate
Table 3: Sources of quarterly unemployment data

Variable
U DIF Fit
Cit
Iit
ADMit
CV 6i,t2
EXM ARit

Mean
0.47
0.11
0.34
0.04
0.02
5.43

Std. Deviation
4.01
0.11
0.13
0.96
0.46
4.67

Minimum
7.80
0.01
0.09
1.00
1.00
13.52

Maximum
11.71
0.43
0.75
1.00
1.00
24.59

Table 4: Summary Statistics, 1975Q1-1998Q2

28

Years
1960Q1-1998Q2
1960Q1-1997Q4
1970Q1-1998Q2
1970Q1-1998Q2
1960Q1-1998Q1
1964Q1-1998Q1
1962Q1-1998Q2
1960Q1-1998Q2
1960Q1-1998Q2
1982Q1-1998Q2
1972Q1-1998Q2
1970Q1-1998Q2
1982Q1-1997Q2
1960Q1-1998Q2
1960Q1-1998Q2

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