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The Inflationary Impact of Wage Indexation

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  • Frank Heinemann

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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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 867.

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

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

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  1. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, Elsevier, vol. 2(2), pages 221-235, April.
  2. 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.
  3. Cukierman, Alex & Lippi, Francesco, 1999. "Central bank independence, centralization of wage bargaining, inflation and unemployment:: Theory and some evidence," European Economic Review, Elsevier, Elsevier, vol. 43(7), pages 1395-1434, June.
  4. Fischer, Stanley & Summers, Lawrence H, 1989. "Should Governments Learn to Live with Inflation?," American Economic Review, American Economic Association, American Economic Association, vol. 79(2), pages 382-87, May.
  5. 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, Elsevier, vol. 23(1), pages 1-29, January.
  6. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(4), pages 1169-89, November.
  7. Giersch, Herbert, 1973. "Indexklauseln und Inflationsbekämpfung," Kiel Discussion Papers 32, Kiel Institute for the World Economy (IfW).
  8. Ball, Laurence, 1988. "Is Equilibrium Indexation Efficient?," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 103(2), pages 299-311, May.
  9. Devereux, Michael, 1987. "The effect of monetary variability on welfare in a simple macroeconomic model," Journal of Monetary Economics, Elsevier, Elsevier, vol. 19(3), pages 427-435, May.
  10. Crosby, Mark, 1995. " Wage Indexation and the Time Consistency of Government Policy," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 97(1), pages 105-12, March.
  11. Devereux, Michael, 1989. "A Positive Theory of Inflation and Inflation Variance," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 27(1), pages 105-16, January.
  12. Karni, Edi, 1983. "On Optimal Wage Indexation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(2), pages 282-92, April.
  13. 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, University of Chicago Press, vol. 91(4), pages 589-610, August.
  14. Ball, Laurence & Cecchetti, Stephen G, 1991. "Wage Indexation and Discretionary Monetary Policy," American Economic Review, American Economic Association, American Economic Association, vol. 81(5), pages 1310-19, December.
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