THE NONNEUTRALITY OF MONETARY POLICY WITH LARGE PRICE OR WAGE SETTERS* DAVID SOSKICE AND T ORBEN IVERSEN Monetary rules matter for the equilibrium rate of employment when the number of price-wage setters is small, even when assuming rational expectations, complete information, central bank precommitment, and absence of nominal rigidities. If the central bank is nonaccommodating, sufficiently large unions, bargaining independently, have an incentive to moderate sectoral money wages, and thereby expected real wages. The result is an increase in the real money supply, and hence higher demand and employment. This does not hold with accommodating monetary policy since unions’ wage decisions cannot then affect the real money supply. A similar argument holds for large monopolistically competitive price setters. I. INTRODUCTION Under a wide range of assumptions, the choice by a central bank of a monetary rule does not affect the equilibrium rate of employment. We show in this article, however, that with a nite number of wage or price setters this is no longer necessarily the case. In particular, we show that a switch by the central bank from an accommodating to a nonaccommodating monetary rule leads to an increase in the equilibrium rate of output or employment, and that this increase is greater the smaller the number of price or wage setters. The result does not challenge the weak neutrality of money theory; given the choice of monetary rule, a change in the money supply has no effect on real variables. 1 Rather, it shows that the strategic interaction of price-wage setters and monetary authorities can have important effects on the equilibrium rate of output and employment. In other words, with a nite number of wage or price setters, the character of the monetary rule is nonneutral. While it may appear at rst sight counterintuitive that an increase in nonaccommodation should increase equilib- rium employment, we show that this is consistent with data for seventeen OECD economies over the period 1973–1993. * We would like to thank Christopher Allsopp, Thomas Cusack, Robert Franzese, Jeffry Frieden, Peter A. Hall, William Novshek, and in particular Alberto Alesina, Olivier Blanchard, and two anonymous referees for their many useful comments and suggestions. The rst author beneted from the environ- ment of the RSSS in the Australian National University in revising this article. 1. Bleaney {1996} shows this to be the case under a similar set of assumptions used here. This result is simply a restatement of the money neutrality thesis—a thesis we obviously do not challenge. r 2000 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology. The Quarterly Journal of Economics, February 2000 265