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Wage Indexation, Inflation Inertia, and the Cost of Disinflation

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  • Javier Gómez

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Abstract

A Statement of the Colombian Consitutional 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 analize the differing slope of the output inflation trade off for diferent 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.

Suggested Citation

  • Javier Gómez, 2002. "Wage Indexation, Inflation Inertia, and the Cost of Disinflation," Borradores de Economia 198, Banco de la Republica de Colombia.
  • Handle: RePEc:bdr:borrec:198
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    References listed on IDEAS

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    1. Rudiger Dornbusch & Stanly Fischer, 1992. "Inflación moderada," Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 11(21), pages 7-68, Junio.
    2. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters,in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc.
    3. Laurence Ball & David Romer, 1989. "Are Prices Too Sticky?," The Quarterly Journal of Economics, Oxford University Press, vol. 104(3), pages 507-524.
    4. Javier Gómez & Juan Manuel Julio, 2001. "Transmission Mechanisms and Inflation Targeting: The Case of Colombia Disinflation," Borradores de Economia 168, Banco de la Republica de Colombia.
    5. Fair, Ray C & Taylor, John B, 1983. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 51(4), pages 1169-1185, July.
    6. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
    7. 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.
    8. Esteban Jadresic, 1996. "Wage Indexation and the Cost of Disinflation," IMF Staff Papers, Palgrave Macmillan, vol. 43(4), pages 796-825, December.
    9. Martha López, 2001. "Seigniorage And The Welfare Cost Of Inflation In Colombia," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE, vol. 19(39), pages 115-131, June.
    10. Ball, Laurence, 1994. "Credible Disinflation with Staggered Price-Setting," American Economic Review, American Economic Association, vol. 84(1), pages 282-289, March.
    11. Ball, Laurence & Croushore, Dean, 2003. " Expectations and the Effects of Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(4), pages 473-484, August.
    12. Rudiger Dornbusch & Stanley Fischer, 1992. "La inflación moderada," Economía Mexicana NUEVA ÉPOCA, , vol. 0(1), pages 5-70, January-J.
    13. Bankim Chadha & Paul R. Masson & Guy Meredith, 1992. "Models of Inflation and the Costs of Disinflation," IMF Staff Papers, Palgrave Macmillan, vol. 39(2), pages 395-431, June.
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    15. 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. Michael Bordo & Pierre Siklos, 2014. "Central Bank Credibility, Reputation and Inflation Targeting in Historical Perspective," NBER Working Papers 20693, National Bureau of Economic Research, Inc.
    2. Javier Gómez & Juan Manuel Julio, 2003. "Transmission Mechanism and Inflation Targeting: The Case of Colombia's Desinflation," Revista de Analisis Economico – Economic Analysis Review, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines, vol. 18(2), pages 109-133, December.
    3. Javier Gómez & José Darío Uribe & Hernando Vargas, 2002. "The Implementation Of Inflation Targeting In Colombia," BORRADORES DE ECONOMIA 003603, BANCO DE LA REPÚBLICA.
    4. Mario Nigrinis Ospina, 2004. "Es lineal la Curva de Phillips en Colombia?," Borradores de Economia 282, Banco de la Republica de Colombia.

    More about this item

    JEL classification:

    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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