We look for a theoretical justification of nominal wage contracts in household diversification of risk. We assume it is more costly for households than for firms to use financial markets for this purpose. 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. When the dominant shock-usually money - is persistent, wage indexation or the auction wage share (each a form of 'real wage protection') rises sharply. OECD experience in the 1970s fits the model's prediction of high wage protection; for the 1990s the model predicts little reduction in protection. The model suggests that the persistence in monetary shocks- implying that the central bank targets the growth rate rather than the level of the money supply (or the price level), or 'base drift' as currently practised throughout the OECD- not only raises wage protection but also reduces welfare in a world where productivity shocks are persistent, as both theory and our empirical results suggest they are. This suggests that this central bank practice is due for review.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Publisher Info
Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
2215.
Find related papers by JEL classification: E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)