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Nominal Contracting and Monetary Targets -- Drifting into Indexation

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Author Info

  • Patrick Minford

    (Cardiff University and CEPR)

  • Eric Nowell

    (University of Liverpool)

  • Bruce Webb

    (Cardiff University)

Abstract

We look for a theoretical justification of nominal wage contracts in household diversification of risk. In a calibrated general equilibrium model we find from stochastic simulation that if both productivity and monetary shocks are temporary then optimal wage contracts are overwhelmingly nominal. The model suggests that the persistence in monetary shocks not only raises wage protection but also reduces welfare in a world where productivity shocks are persistent, as both theory and our empirical results for the OCED suggest they are. This suggests that this central bank practice is due for review. Copyright Royal Economic Society 2003.

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Bibliographic Info

Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 113 (2003)
Issue (Month): 484 (January)
Pages: 65-100

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Handle: RePEc:ecj:econjl:v:113:y:2003:i:484:p:65-100

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References

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  1. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
  2. Caplin, Andrew & Leahy, John, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 683-708, August.
  3. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
  4. Coenen, Günter & Wieland, Volker, 2000. "A small estimated euro area model with rational expectations and nominal rigidities," Working Paper Series 0030, European Central Bank.
  5. Malcomson, J., 1998. "Individual employment contracts," Discussion Paper Series In Economics And Econometrics 9804, Economics Division, School of Social Sciences, University of Southampton.
  6. Andrews, M J & Minford, A P L & Riley, J, 1996. "On Comparing Macroeconomic Models Using Forecast Encompassing Tests," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 58(2), pages 279-305, May.
  7. Richard Rogerson, 2010. "Indivisible Labor, Lotteries and Equilibrium," Levine's Working Paper Archive 250, David K. Levine.
  8. Jovanic, Boyan & Ueda, Masako, 1997. "Contracts and Money," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 700-708, August.
  9. Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780199279173.
  10. Minford, Patrick & Brech, Michael & Matthews, Kent, 1980. "A rational expectations model of the U.K. under floating exchange rates," European Economic Review, Elsevier, vol. 14(2), pages 189-219.
  11. Bennett T. McCallum & Edward Nelson, 1997. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," NBER Working Papers 5875, National Bureau of Economic Research, Inc.
  12. Barro, Robert J., 1977. "Long-term contracting, sticky prices, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 3(3), pages 305-316, July.
  13. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 163-90, February.
  14. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  15. Cho, Jang-Ok & Cooley, Thomas F & Phaneuf, Louis, 1997. "The Welfare Cost of Nominal Wage Contracting," Review of Economic Studies, Wiley Blackwell, vol. 64(3), pages 465-84, July.
  16. Baily, Martin Neil, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 37-50, January.
  17. Minford, Patrick, 1983. "Labour Market Equilibrium in an Open Economy," Oxford Economic Papers, Oxford University Press, vol. 35(0), pages 207-44, Supplemen.
  18. Michael Magill & Martine Quinzii, 1997. "Which improves welfare more: A nominal or an indexed bond?," Economic Theory, Springer, vol. 10(1), pages 1-37.
  19. James Tobin, 1956. "Liquidity Preference as Behavior Towards Risk," Cowles Foundation Discussion Papers 14, Cowles Foundation for Research in Economics, Yale University.
  20. Sheshinski, Eytan & Weiss, Yoram, 1977. "Inflation and Costs of Price Adjustment," Review of Economic Studies, Wiley Blackwell, vol. 44(2), pages 287-303, June.
  21. Danthine, Jean-Pierre & Donaldson, John B, 1996. "Labour Contracts, Operating Leverage and Asset Pricing," CEPR Discussion Papers 1353, C.E.P.R. Discussion Papers.
  22. Lucas, Robert E, Jr, 1996. "Nobel Lecture: Monetary Neutrality," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 661-82, August.
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Citations

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Cited by:
  1. Vo Le & Patrick Minford, 2006. "Joining the European Monetary Union—Comparing First and Second Generation Open Economy Models," Open Economies Review, Springer, vol. 17(3), pages 281-296, July.
  2. Le, Vo Phuong Mai & Minford, Patrick, 2007. "Optimising indexation arrangements under Calvo contracts and their implications for monetary policy," Cardiff Economics Working Papers E2007/7, Cardiff University, Cardiff Business School, Economics Section.
  3. Matthews, Kent & Meenagh, David & Minford, Patrick & Webb, Bruce, 2006. "Monetary regimes: is there a trade-off between consumption and employment variability?," Cardiff Economics Working Papers E2006/12, Cardiff University, Cardiff Business School, Economics Section.
  4. Le, Vo Phuong Mai & Minford, Patrick, 2006. "Joining the European Monetary Union - Comparing First and Second Generation Open Economy Models," CEPR Discussion Papers 5615, C.E.P.R. Discussion Papers.
  5. Julio A. Carrillo & Gert Peersman & Joris Wauters, 2013. "Endogenous Wage Indexation and Aggregate Shocks," Working Papers 2013-19, Banco de México.
  6. Michael, Hatcher, 2013. "Indexed versus nominal government debt under inflation and price-level targeting," SIRE Discussion Papers 2013-56, Scottish Institute for Research in Economics (SIRE).

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