Wage Indexation and Output Stability Revisited
Since Gray (1976) and Fischer (1977), the accepted view is that wage indexation stabilizes output when shocks are nominal and destabilizes output when shocks are real. This paper examines this proposition's validity when wage indexation is based on lagged inflation. It shows that: (i) in a Gray-Fischer economy with plausible parameters, indexing wages to lagged inflation destabilizes output regardless of the type of shocks; (ii) the Gray-Fischer result may be restored if nominal shocks have a strong direct effect on prices, given wages; and (iii) wage indexation to lagged inflation can be neutral for output stability if monetary policy is accommodative.
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Volume (Year): 34 (2002)
Issue (Month): 1 (February)
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