Macroeconomic Stabilization Through Taxation and Indexation: the Use Offirm-Specific Information

Abstract

This paper considers two alternative approaches to stabilizing an economy with firm-specific productivity disturbances. The first uses wage contracts tying wages in each firm to these disturbances as well as the price level. The second uses a tax on firms which modifies their supply behavior together with a simple waqe indexation rule tying wages to prices alone. Both these schemes are viable as long as the firm-specific disturbance is known to all agents. If the firm alone observes the productivity disturbance, under either scheme it has an incentive to misrepresent current conditions. However, a combination of these two schemes is both welfare maximizing and incentive compatible.