constructed to reduce the costs of the commitment problem. that problem may lead to inefficient outcomes - the coase theorem does not apply to collective decisions. 6 it is useful to think about the optimal design of monetary institutions using the insights from the theory of incomplete contracts. that theory discusses what contracts would look like if certain aspects of the world could not be verified by an outside enforcer of the contract. in terms of monetary policy, there are two related though distinct aspects of the commitment problem. first, the inability to enforce commitment, because monetary arrangements can always be changed in the absence of an outside enforcer, means that no such torsten persson and guido tabellini ( 1999 ) argue that if it takes sufficient time for a government to tear up contracts designed to eliminate the inflation bias ( longer than the duration of nominal contracts ) promises not to inflate can be credible. svensson ( 2002 ) takes the same view of mccallum ( 1995 ) in his comments on stokey ( 2002 ), thus : “ … to my knowledge neither mccallum nor anyone else has presented a model where ‘ just do it ’ is an equilibrium outcome. ” [ p4 ]. “ the institutional structure of monetary union forms the basis for public trust in the euro and rests on two pillars : the stabilityoriented monetary constitution enshrined in the maastricht treaty, and the stability and growth pact. both pillars are being undermined, leaving european monetary union in a very grave predicament ”. ( ernst welteke, the times, 4 december 2003 ). daron acemoglu ( 2003 ) argues that inefficient policies can occur in a democracy because those in political power cannot commit to maintaining the policies that are required to achieve efficient outcomes. in other words, the coase theorem does not apply at the level of society as a whole. arrangement is sacrosanct for all time. thomas jefferson believed that the us constitution should be rewritten every 20 years or so at a new constitutional convention. 7 second, we cannot fully describe an optimal monetary arrangement because we do not know all possible states of the world and hence the policy rule to which we would like to commit. those two aspects of the technology of collective decisions create a role for institutions. but they differ in important ways. if there were only a commitment problem, then we could describe an optimal state - contingent monetary policy reaction function. mechanisms could then be devised to make it

mr king explores lessons from the uk labour market text of the employment policy institute ’ s fourth annual lecture delivered by the deputy governor of the bank of england, mr mervyn king, held in london on 1 / 12 / 98. it is both an honour and a challenge to deliver the fourth epi lecture. it is an honour to follow in such distinguished footsteps, and it is a challenge to tackle the subject of the link between monetary policy and the labour market. few subjects are as emotive. wages, jobs and unemployment feature as frequently in the popular press as they do in academic articles. the bank of england must learn from one in order to convey our message in the other. and we are fortunate in that labour economics is a field in which british economists have been – and continue to be – at the forefront of research. that i can say objectively because i am not myself a labour economist. so tonight i shall be exploring lessons from the labour market for the monetary policy committee. the employment policy institute has played an important role in bringing together those undertaking research on labour markets and those involved with policy decisions. in particular, its employment audit provides a valuable commentary on current developments. the labour market is unlike any other market. indeed, for many people the very language of economists – equilibrium unemployment, market - clearing wages – seems incompatible with the human dimension of unemployment and deprivation. are the 16 million unemployed people in the european union merely an equilibrium, on the one hand, and a statistic, on the other? but for most people the labour market is the market where – for better or worse, in sickness or in health – they sell their time and their skills at a market price. that price determines, in large part, their opportunities and economic welfare. wage rates have a much greater significance in influencing the distribution of real incomes than do the prices of almost anything else. as a result, the labour market cannot be divorced from broader social and political considerations. if their terminology and language are sometimes insensitive, what do economists have to offer by way of ideas about unemployment? the prize for the most important idea and most insensitive terminology surely goes to milton friedman for the concept of the natural rate of unemployment. i shall discuss shortly the significance of this idea for monetary policy. but for a more elegant advocacy of a similar position it is necessary to delve further back in history. this month sees the 75th anniversary of the publication of what milton friedman described as john maynard keynes ’ best