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Wage Indexation, Inflation Inertia, and the Cost of Disinflation - New version

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  • Javier Gómez

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    Abstract

    A Statement of the Colombian Consitutional Court has mandated wage indexation on the basis of past inflation. A simple model with a wage price system, a real block, and an inflation targeting interest rule is calibrated to resemble price setting in the colombian economy and to analize the differing slope of the output inflation trade off for diferent specifications of wage indexation. The disinflation experiments show that backward looking indexation increases inflation inertia, decreases the effect of monetary policy, and increases the cost of disinflation. Shorter wage contracts and more frequent wage negotiations do not appear to have important effects on the cost of disinflation. Higher central bank credibility and the use of forward looking inflation expectations in wage negotiations decrease the cost of disinflation and may eventually lead to a boom.

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    Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 198nv.

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    Handle: RePEc:bdr:borrec:198nv

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    1. N. Gregory Mankiw, 1994. "Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number greg94-1, June.
    2. Bankim Chadha & Paul R. Masson & Guy Meredith, 1992. "Models of Inflation and the Costs of Disinflation," IMF Staff Papers, Palgrave Macmillan, vol. 39(2), pages 395-431, June.
    3. Laurence Ball & Dean Croushore, 2001. "Expectations and the effects of monetary policy," Working Papers 01-12, Federal Reserve Bank of Philadelphia.
    4. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
    5. Ray C. Fair & John B. Taylor, 1980. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear RationalExpectations Models," NBER Technical Working Papers 0005, National Bureau of Economic Research, Inc.
    6. Esteban Jadresic, 1996. "Wage Indexation and the Cost of Disinflation," IMF Working Papers 96/48, International Monetary Fund.
    7. Ball, Laurence, 1994. "Credible Disinflation with Staggered Price-Setting," American Economic Review, American Economic Association, vol. 84(1), pages 282-89, March.
    8. Ball, Laurence & Cecchetti, Stephen G, 1991. "Wage Indexation and Discretionary Monetary Policy," American Economic Review, American Economic Association, vol. 81(5), pages 1310-19, December.
    9. Laurence M. Ball & David Romer, 1987. "Are Prices Too Sticky?," NBER Working Papers 2171, National Bureau of Economic Research, Inc.
    10. Javier Gómez & Juan Manuel Julio, . "Transmission Mechanisms and Inflation Targeting: The Case of Colombia Disinflation," Borradores de Economia 168, Banco de la Republica de Colombia.
    11. Rudiger Dornbusch & Stanley Fischer, 1992. "La inflación moderada," Economia Mexicana NUEVA EPOCA, , vol. 0(1), pages 5-70, January-J.
    12. Esteban Jadresic, 1996. "Wage Indexation and the Cost of Disinflation," IMF Staff Papers, Palgrave Macmillan, vol. 43(4), pages 796-825, December.
    13. Fischer, Stanley & Summers, Lawrence H, 1989. "Should Governments Learn to Live with Inflation?," American Economic Review, American Economic Association, vol. 79(2), pages 382-87, May.
    14. Rudiger Dornbusch & Stanly Fischer, 1992. "Inflación moderada," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE.
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