When should labor contracts be nominal?
This paper proposes a theory of when labor contract should be nominal or, instead, indexed. We find that, contracts should be indexed if prices are difficult to forecast and nominal otherwise. We use a principal-agent model developed by Jovanovic and Ueda (1997), with moral hazard, renegotiation, and where a signal (the nominal value of the sales of the agent) is observed before renegotiation takes place. We show that their result, that the optimal contract is nominal when agents must choose pure strategies, is robust to the case where agents can choose mixed strategies in the sense that, for certain parameters, the optimal contract is still nominal. For other parameters, however, we show that the optimal contract is indexed. Our findings are consistent with two empirical regularities. First prices are more volatile with higher inflation and, second, countries with high inflation tend to have indexed contracts. Our theory suggests that it is because prices are difficult to forecast in high inflation countries that contracts are indexed.
|Date of creation:||2000|
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- Guido Tabellini & Scott Freeman, 1998.
"The optimality of nominal contracts,"
Springer;Society for the Advancement of Economic Theory (SAET), vol. 11(3), pages 545-562.
- Freeman, Scott & Tabellini, Guido, 1991. "The optimality of nominal contracts," Working Papers 9114, Federal Reserve Bank of Dallas.
- Scott Freeman & Guido Tabellini, 1991. "The Optimality of Nominal Contracts," NBER Technical Working Papers 0110, National Bureau of Economic Research, Inc.
- Azariadis, Costas & Cooper, Russell, 1985. "Nominal Wage-Price Rigidity as a Rational Expectations Equilibrium," American Economic Review, American Economic Association, vol. 75(2), pages 31-35, May.
- Russell Cooper, 1990. "Predetermined Wages and Prices and the Impact of Expansionary Government Policy," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 205-214.
- Fudenberg, Drew & Tirole, Jean, 1990. "Moral Hazard and Renegotiation in Agency Contracts," Econometrica, Econometric Society, vol. 58(6), pages 1279-1319, November.
- Drew Fudenberg & Jean Tirole, 1988. "Moral Hazard and Renegotiation in Agency Contracts," Working papers 494, Massachusetts Institute of Technology (MIT), Department of Economics.
- Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
- Azariadis, Costas, 1978. "Escalator clauses and the allocation of cyclical risks," Journal of Economic Theory, Elsevier, vol. 18(1), pages 119-155, June.
- Costas Azariadis & Russell Cooper, 1985. "Predetermined Prices and the Allocation of Social Risks," The Quarterly Journal of Economics, Oxford University Press, vol. 100(2), pages 495-518.
- Martin Neil Baily, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 37-50.
- Jovanic, Boyan & Ueda, Masako, 1997. "Contracts and Money," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 700-708, August.
- Jovanovic, B. & Ueda, M., 1996. "Contracts and Money," Working Papers 96-23, C.V. Starr Center for Applied Economics, New York University.
- Boyan Jovanovic & Masako Ueda, 1996. "Contracts and Money," NBER Working Papers 5637, National Bureau of Economic Research, Inc.
- Holland, A Steven, 1995. "Inflation and Wage Indexation in the Postwar United States," The Review of Economics and Statistics, MIT Press, vol. 77(1), pages 172-176, February.
- Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
- Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February. Full references (including those not matched with items on IDEAS)
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