Journal Issue

Summary of WP/92/67

International Monetary Fund
Published Date:
January 1993
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Summary of WP/92/67

“Wage and Public Debt Indexation” by Pablo E. Guidotti

This paper studies the relationship that may exist between indexation of the public debt and indexation of wages. The analysis combines Calvo and Guidotti’s (1990) theory of public debt indexation with Gray’s (1976) theory of optimal wage indexation. Blending and expanding these two approaches results in surprising richness. Decisions regarding the indexation of the public debt and those regarding wage indexation are interrelated. The Calvo-Guidotti framework is enriched by accounting for output and employment fluctuations in the government’s objective function and by introducing the issue of imperfect controllability of inflation into the optimal taxation problem. The Fischer-Gray approach--in particular, Gray’s (1976) model--is enriched by making monetary shocks endogenous. In particular, the monetary shock reflects the state-contingent response of the rate of monetary expansion to stochastic variations in government expenditure. The endogenous distribution of the rate of monetary expansion, in turn, is a function of the government’s choice of debt indexation and the private sector’s decision regarding wage indexation.

A number of insights emerge from the analysis. As far as the government’s fiscal decisions are concerned, wage and debt indexation are positively related: higher wage indexation increases unwanted inflation volatility and induces the government to increase the degree of public debt indexation. Since higher public debt indexation reduces the policymaker’s incentive to resort to inflation, a higher degree of wage indexation induces the government to adopt a more anti-inflationary policy stance.

As far as the private sector is concerned, wage and debt indexation may be positively or negatively related. Whether higher debt indexation induces wage setters to choose a higher or lower degree of wage indexation depends on the effect that debt indexation has on the variability of the rate of money growth. If higher debt indexation leads to increased monetary volatility, then wage setters will choose higher wage indexation. If higher debt indexation leads to decreased monetary volatility, the optimal degree of wage indexation declines. The intuition behind these two alternative effects of debt indexation is discussed in detail.

Equilibrium wage and debt indexation represent a Nash equilibrium. The paper analyzes the responses of wage and debt indexation to exogenous changes--such as changes in the distribution of monetary and real shocks, variations in government expenditure, and changes in the level of public debt. Whether wage and debt indexation respond to exogenous developments by moving in the same or opposite directions depends on the initial equilibrium, the nature of the change, and the policy response. The analysis shows, however, that the presumption that one form of indexation leads to the other does not receive general support.

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