Asymmetric Wage Indexation
James Peery Cover
University of Alabama - Department of Economics, Finance and Legal Studies
David D. VanHoose
Baylor University - Department of Economics
March 5, 2002
Atlantic Econ. J. 30(1): pp. 34-47, March 2002
Models of wage indexation uniformly have been based on the simplifying assumption that nominal wages adjust upward or downward symmetrically with unexpected price increases or decreases. Indexation typically is asymmetric in actual contracts, however. Wages are indexed to price increases but not to price reductions. This paper analyzes a macroeconomic model with asymmetric indexation. On the one hand, this paper finds that when stable equilibria supporting use of such asymmetrically indexed contracts exist, the result is an unambiguous downward bias in the base contract wage, because workers must pay a premium for insurance against real wage reductions that unexpected inflation otherwise would induce. On the other hand, the paper concludes that the likelihood of existence of stable equilibria supporting positive wage indexation generally declines as aggregate demand variability rises relative to the variability of aggregate supply. This may help explain why relatively low levels of wage indexation actually are observed in nations with relatively contained aggregate demand volatility.
Keywords: wage indexation, asymmetry
JEL Classification: E24Accepted Paper Series
Date posted: June 6, 2012
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