Wage Indexation and Time-Consistent Monetary Policy

Abstract

This paper investigates the effects of wage indexation on the time-consistent level of inflation. Departing from previous work on time-consistent policy, we study a structural model of the economy. Indexation reduces the cost of inflation, which is inflationary, and steepens the Phillips curve, which is anti-inflationary. In most cases, the net effect is to raise inflation but also to raise welfare: the loss from higher inflation is outweighed by the gain from greater protection against inflation.