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The Inflationary Impact of Wage Indexation

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Author Info
Frank Heinemann

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Abstract

It is an open question whether and how indexed wage contracts reduce welfare or raise average inflation. This paper analyzes the impact of indexed wage contracts on inflation and social welfare in a Barro--Gordon model with discretionary monetary policy by endogenizing social costs of indexation. Main results are: Wage indexation reduces the inflation bias but may raise the variance of inflation rates. In social optimum wages are fully indexed to the price level, but this requires optimal wage adjustments to productivity shocks. If wage adjustments to productivity are suboptimal, the second best solution calls for non--indexed wage contracts and a central banker with balanced aspiration levels of employment and real wages. In case of decentralized wage bargaining, a prohibition of wage indexation may improve welfare.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 867.

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Date of creation: 2003
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Handle: RePEc:ces:ceswps:_867

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Related research
Keywords: monetary policy; Phillips curve; wage bargaining; wage indexation;

Find related papers by JEL classification:
E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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  1. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November. [Downloadable!] (restricted)
  2. Duca, John V. & Van Hoose, David D., 2001. "The Rise of Goods-Market Competition and the Fall of Nominal Wage Contracting: Endogenous Wage Contracting in a Multisector Economy," Journal of Macroeconomics, Elsevier, vol. 23(1), pages 1-29, January. [Downloadable!] (restricted)
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  3. Adolph, Brigitte & Wolfstetter, Elmar, 1991. "Wage-Indexation, Informational Externalities, and Monetary Policy," Oxford Economic Papers, Oxford University Press, vol. 43(3), pages 368-90, July. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
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  5. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April. [Downloadable!] (restricted)
  6. 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. [Downloadable!] (restricted)
  7. Ball, Laurence, 1988. "Is Equilibrium Indexation Efficient?," The Quarterly Journal of Economics, MIT Press, vol. 103(2), pages 299-311, May. [Downloadable!] (restricted)
  8. Devereux, Michael, 1987. "The effect of monetary variability on welfare in a simple macroeconomic model," Journal of Monetary Economics, Elsevier, vol. 19(3), pages 427-435, May. [Downloadable!] (restricted)
  9. Karni, Edi, 1983. "On Optimal Wage Indexation," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 282-92, April. [Downloadable!] (restricted)
  10. Crosby, Mark, 1995. " Wage Indexation and the Time Consistency of Government Policy," Scandinavian Journal of Economics, Blackwell Publishing, vol. 97(1), pages 105-12, March.
  11. Devereux, Michael, 1989. "A Positive Theory of Inflation and Inflation Variance," Economic Inquiry, Oxford University Press, vol. 27(1), pages 105-16, January.
  12. 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. [Downloadable!] (restricted)
  13. Cukierman, A. & Lippi, F., 1998. "Central bank independence, centralization of wage bargaining, inflation and unemployment : theory and some evidence," Discussion Paper 116, Tilburg University, Center for Economic Research. [Downloadable!]
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