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Wage Indexation, Inflation Inertia, and The Cost of Disinflation

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  • Javier Gómez Pineda

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    Abstract

    Abstract A Statement of the Colombian Constitutional 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 analyze the differing slope of the output inflation trade off for different 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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    File URL: http://www.banrep.gov.co/docum/ftp/borra198.pdf
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    Bibliographic Info

    Paper provided by BANCO DE LA REPÚBLICA in its series BORRADORES DE ECONOMIA with number 003770.

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    Length: 18
    Date of creation: 28 Feb 2002
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    Handle: RePEc:col:000094:003770

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    1. Guy Meredith & Bankim Chadha & Paul R. Masson, 1991. "Models of Inflation and the Costs of Disinflation," IMF Working Papers 91/97, International Monetary Fund.
    2. 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.
    3. Rudiger Dornbusch & Stanly Fischer, 1992. "Inflación moderada," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE.
    4. Laurence Ball, 1990. "Credible Disinflation with Staggered Price Setting," NBER Working Papers 3555, National Bureau of Economic Research, Inc.
    5. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters, in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc.
    6. Esteban Jadresic, 1996. "Wage Indexation and the Cost of Disinflation," IMF Staff Papers, Palgrave Macmillan, vol. 43(4), pages 796-825, December.
    7. Laurence Ball & Dean Croushore, 2001. "Expectations and the effects of monetary policy," Working Papers 01-12, Federal Reserve Bank of Philadelphia.
    8. Ray C. Fair & John B. Taylor, 1980. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Cowles Foundation Discussion Papers 564, Cowles Foundation for Research in Economics, Yale University.
    9. Rudiger Dornbusch & Stanley Fischer, 1992. "La inflación moderada," Economia Mexicana NUEVA EPOCA, , vol. 0(1), pages 5-70, January-J.
    10. 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.
    11. repec:nbr:nberre:0126 is not listed on IDEAS
    12. 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.
    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, vol. 91(4), pages 589-610, August.
    14. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
    15. repec:sae:niesru:v:145:y::i:1:p:43-63 is not listed on IDEAS
    16. Esteban Jadresic, 1996. "Wage Indexation and the Cost of Disinflation," IMF Working Papers 96/48, International Monetary Fund.
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    Cited by:
    1. Luis Fernando Melo Velandia & Martha Alicia Misas Arango, 2004. "Modelos Estructurales de Inflación en Colombia: Estimación a través de Mínimos Cuadrados Flexibles," BORRADORES DE ECONOMIA 003244, BANCO DE LA REPÚBLICA.
    2. Javier Gómez & José Darío Uribe & Hernando Vargas, 2002. "The Implementation Of Inflation Targeting In Colombia," BORRADORES DE ECONOMIA 003603, BANCO DE LA REPÚBLICA.

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