Wage indexation: A macroeconomic approach

This essay examines the role of wage indexation in dampening macroeconomic fluctuations in a simple neoclassical model modified to incorporate short-term wage rigidities and uncertainty. The analysis departs from most of the previous literature on indexing in its explicit consideration of real disturbances. It is found that while indexing insulates the real sector from the effects of monetary shocks, it may exacerbate the real effects of real shocks. Thus the analysis suggests an optimal degree of partial indexation that depends on the underlying stochastic structure of the economy. Consequently, optimal indexing will not, in general, insulate the real sector from monetary variability.