Back Matter

References

  • Adams, Charles, and David T. Coe,A Systems Approach to Estimating the Natural Rate of Unemployment and Potential Output for the United States,Staff Papers, International Monetary Fund, Vol. 37, No. 2 (June 1990), pp. 23293.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Aizenman, Joshua,Wage Indexation,” in J. Eatwell, M. Milgate, and P. Newman (eds.), The New Palgrave: A Dictionary of Economics, (London: MacMillan, 1987), pp. 83840.

    • Search Google Scholar
    • Export Citation
  • Blanchard, Oliver J., and Stanley Fischer, Lectures on Macroeconomics, MIT Press Cambridge, Massachusetts: 1989).

  • Blanchflower, David G., and Andrew J. Oswald,An Introduction to the Wage Curve,Journal of Economic Perspectives, Vol. 9, No. 3, (Summer 1995), pp. 15367.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Carmichael, Jeffrey, Jerome Fahrer, and John Hawkins,Some Macroeconomic Implications of Wage Indexation: A Survey,” in V. E. Argy and J. W. Nevile (eds.), Inflation and Unemployment: Theory, Experience, and Policy-Making, George Allen and Unwin (London: 1986), pp. 78102.

    • Search Google Scholar
    • Export Citation
  • Devereux, Michael,Wage Indexation, Adjustment, and Inflation,” in S. Horton, R.S.M. Ravi, and D. Mazumdar (eds.) Labor Market in an Era of Adjustment, Vol. 1, (Washington: World Bank, 1994), pp. 195236.

    • Search Google Scholar
    • Export Citation
  • Fischer, Stanley,Wage Indexation and Macroeconomic Stability,” in Stabilization of the Domestic and International Economy, Carnegie-Rochester Conference Series on Public Policy, Vol. 5, (Amsterdam; New York: North Holland, 1977), pp. 10748.

    • Search Google Scholar
    • Export Citation
  • Friedman, Milton,Monetary Correction: A Proposal for Escalator Clauses to Reduce the Costs of Ending Inflation,” in Griesch et al. Essays on Inflation and Indexation, American Enterprise Institute (Washington: 1974).

    • Search Google Scholar
    • Export Citation
  • Gray, Jo Anna,Wage Indexation--A Macroeconomic Approach,Journal of Monetary Economics, Vol. 2, No. 2 (April 1976), pp. 22135.

  • Jadresic, Esteban (1996a), “Wage Indexation and the Cost of Disinflation,IMF Working Paper 96/48, also forthcoming in Staff Papers, (Washington: International Monetary Fund).

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Jadresic, Esteban, (1996b) “Wage Indexation and the Choice of Exchange Rate Regime,IMF Working Paper, (forthcoming).

  • Simonsen, Mario H.,Indexation: Current Theory and the Brazilian Experience,” in Dornbusch, Rudiger, and Mario H. Simonsen (eds.), Inflation, Debt, and Indexation, MIT Press (Cambridge, Massachusetts: 1983), pp. 99132. Turnovsky, Stephen J., Methods of Macroeconomic Dynamics, MIT Press (Cambridge, Massachusetts: 1995).

    • Search Google Scholar
    • Export Citation
  • Van Gompel, Johan,Stabilization with Wage Indexation and Exchange Rate Flexibility,Journal of Economic Surveys, Vol. 8, No. 3 (1994), pp. 251281.

    • Crossref
    • Search Google Scholar
    • Export Citation
*

I am grateful to Mike Devereux and Peter Wickham for helpful comments

1

The wage indexation literature has been reviewed by Carmichael, Fahrer and Hawkins (1985), Aizenman (1987), Devereux (1994), and Van Gompel (1994); also see Turnovsky (1995, chapter 8) and the introduction to Jadresic (1996a).

2

Although many authors have emphasized that actual wage indexation is lagged, the most influential on this respect has been Simonsen (1983). He disputed Friedman’s (1974) view that wage indexing reduces the cost of disinflation and conjectured that because of the lags in actual indexation rules, wage indexing increases the cost of disinflation. Jadresic (1996a) has shown recently that both Friedman’s and Simonsen’s points of view can be correct depending on the yardstick used to evaluate the effects of wage indexing: contracts that index wages to lagged inflation reduce the cost of disinflation in comparison to contracts that specify time-varying wages, but tend to increase them in comparison to contracts that specify fixed wages.

3

Admittedly, Fischer (1977) was concerned about the lack of realism of the assumption of contemporaneous wage indexation and, in a section of his paper that he considered to provide the major theoretical innovation, he studied formally the effects of a certain type of lagged indexation rule. Nonetheless, the formula he studied is not the usual indexation rule by which current wages are adjusted according to past inflation; rather, it is a rule by which current wages are adjusted according to the difference between the one-period-ahead expectations on the current and past price level. Fischer, indeed, warned explicitly that the indexing formulae used in practice may be a far cry from the indexation rule he studied.

4

The stylized fact is that in practice there is no significant effect of output on prices, given wages. Most empirical studies are consistent with the notion that marginal costs are roughly constant or perhaps even declining. In addition, there are several theoretical reasons why imperfectly competitive firms may choose countercyclical mark-ups. See Blanchard and Fischer (1989, pp. 464–7).

5

I do not consider explicitly two-period fixed wage contracts because, in practice, fixed wage contracts tend to be shorter in duration than indexed and preset time-varying wage contracts. Besides, considering them explicitly is irrelevant in the context of the model being presented, because it can be shown that with fixed money supply, the behavior of the economy with two-period fixed wage contracts is exactly the same as with two-period preset time-varying wage contracts.

6

This implies that wage setters attempt to keep constant the functional distribution of income. Empirically, this assumption is supported by the results of Blanchflower and Oswald’s (1995) extensive research on the “wage-curve”. Indeed, their central finding from data for a number of regions and periods is that a 1 percent increase in the unemployment rate typically reduces the real wage by 0.1 percent. With standard estimates for Okun’s Law coefficient (between 2 and 3; for example, see Adams and Coe (1990)), it follows that a 1 percent increase in GDP would raise the real wage by the order of 1 percent (given a 5 percent unemployment rate).

7

With fully flexible wages and perfect information, wage setters would set wt = πt + yt; it follows from equation (2) that the rate of change of the frictionless level of output is ut.

8

To derive these equations, a common unit root in the output gaps and the shock terms were eliminated from the system by backward integration; the arbitrary constants resulting from the integration process were normalized to zero for convenience.

9

The oscillatory and convergent nature of the evolution of output can be verified by computing the roots of the characteristic equation associated with equation (10), which are both imaginary and have the property that the multiplication of their inverses is smaller than one. The associated damping factor can be shown to be (5+4α)−t, implying that increasing α speeds up the adjustment of the economy.

10

This result can be derived from equations (13) and (14) obtained below by using the property that the sum of squared output gaps caused by a single nominal shock is equivalent to the unconditional variance of the output gap caused by infinitely repeated nominal shocks (this equality holds because the nominal shocks are uncorrelated). The number 0.2728 is an approximation to a number with more decimals.

11

As in the case of a real shock, this process of adjustment can be verified by computing the roots of the characteristic equation associated with equation (10).

Wage Indexation and Macroeconomic Stability: The Gray-Fischer Theorem Revisted
Author: Mr. Esteban Jadresic