The Inflationary Impact of Wage Indexation

25 Pages Posted: 6 Mar 2003

See all articles by Frank Heinemann

Frank Heinemann

Berlin Institute of Technology; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: February 2003

Abstract

It is an open question whether and how indexed wage contracts reduce welfare or raise average inflation. This paper analyzes the impact of indexed wage contracts on inflation and social welfare in a Barro-Gordon model with discretionary monetary policy by endogenizing social costs of indexation. Main results are: Wage indexation reduces the inflation bias but may raise the variance of inflation rates. In social optimum wages are fully indexed to the price level, but this requires optimal wage adjustments to productivity shocks. If wage adjustments to productivity are suboptimal, the second best solution calls for non-indexed wage contracts and a central banker with balanced aspiration levels of employment and real wages. In case of decentralized wage bargaining, a prohibition of wage indexation may improve welfare.

Keywords: Monetary Policy, Phillips Curve, Wage Bargaining, Wage Indexation

JEL Classification: E24, E52

Suggested Citation

Heinemann, Frank, The Inflationary Impact of Wage Indexation (February 2003). Available at SSRN: https://ssrn.com/abstract=385121 or http://dx.doi.org/10.2139/ssrn.385121

Frank Heinemann (Contact Author)

Berlin Institute of Technology ( email )

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CESifo (Center for Economic Studies and Ifo Institute) ( email )

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