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Designing Indexed Units of Account

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Abstract

An indexed unit of account is a unit of measurement defined using an index such as a consumer price index so that prices, wages or deferred payments defined in terms of these units will automatically adjust to changing economic conditions. Evidence on money illusion and sticky prices, and evidence from countries (notably Chile) that have created indexed units of account, suggests that creating such indexed units is an important policy option for governments in countries with unstable prices or incomes. Choices for governments designing indexed units of account are discussed. Governments may choose to encourage the use of the units only for large long-deferred non-wage payments, or they may choose to go to the opposite extreme of encouraging the use of the units for defining all prices, wages and payments. A general equilibrium model is given that shows the dynamics of prices when all prices are expressed in the units. Governments may choose to link units to a consumer price index or to a per capita income index, and there may be advantages to creating both kinds of units simultaneously. Downward rigidity of real wages might be reduced if wages are denominated in base-income-indexed units of account, where base income is defined so that the growth rate in money value of the unit is biased down relative to actual per capita income growth. Examples of the units for United States are displayed and discussed. Could add description of simulation, if that is added.

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File URL: http://cowles.econ.yale.edu/P/cd/d11b/d1179.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1179.

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Length: 23 pages
Date of creation: May 1998
Date of revision:
Publication status: Published in Lawrence R. Klein, ed., Long-run Growth and Short-run Stabilization: Essays in Memory of Albert Ando, Elgar, 2006, pp. 288-302
Handle: RePEc:cwl:cwldpp:1179

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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: Indexation; escalator clause; cost of living allowance (COLA); monetized indexed units of account; base income; money illusion; sticky prices; fairness; unidad de fomento; Chile;

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References

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  1. Robert J. Shiller, 1997. "Public Resistance to Indexation: A Puzzle," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(1), pages 159-228.
  2. Robert J. Shiller & Ryan Schneider, 1995. "Labor Income Indices Designed for Use in Contracts Promoting Income Risk Management," NBER Working Papers 5254, National Bureau of Economic Research, Inc.
  3. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  4. Robert J. Shiller, 2002. "Indexed Units of Account: Theory and Assessment of Historical Experience," Central Banking, Analysis, and Economic Policies Book Series, in: Fernando Lefort & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Serie (ed.), Indexation, Inflation and Monetary Policy, edition 1, volume 2, chapter 4, pages 105-134 Central Bank of Chile.
  5. Robert E. Hall, 1982. "Explorations in the Gold Standard and Related Policies for Stabilizing the Dollar," NBER Chapters, in: Inflation: Causes and Effects, pages 111-122 National Bureau of Economic Research, Inc.
  6. Laurence Ball & N. Gregory Mankiw, 1992. "Relative-Price Changes as Aggregate Supply Shocks," NBER Working Papers 4168, National Bureau of Economic Research, Inc.
  7. Stanley Fischer & Franco Modigliani, 1978. "Towards An Understanding of the Real Effects and Costs of Inflation," NBER Working Papers 0303, National Bureau of Economic Research, Inc.
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  9. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, December.
  10. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
  11. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
  12. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, vol. 76(4), pages 728-41, September.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Ghost Money: Chile's Unidad de Fomento
    by JP Koning in Moneyness on 2013-09-23 14:57:00
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Cited by:
  1. Hyung Sun Choi & Ohik Kwon & Manjong Lee, 2013. "Inflation, Credit, and Indexed Unit of Account," Discussion Paper Series 1307, Institute of Economic Research, Korea University.
  2. Edgardo Barandiarán, 2000. "Chile Después del Peso: Viviendo con el Dólar," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 37(110), pages 241-267.
  3. Jan Overgaard Olesen, . "A Simple Explanation of Stock Price Behavior in the Long Run: Evidence for Denmark," EPRU Working Paper Series 00-09, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  4. Olivier Blanchard, 2000. "What do we know about Macroeconomics that Fisher and Wicksell did not?," NBER Working Papers 7550, National Bureau of Economic Research, Inc.

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