Wage Indexation and Time Consistency: Note

This note presents a simple model where the decision on the degree of wage indexation is taken by a 'large' agent, such as the government. The optimal degree of indexing is shown to depend on the variance of real shocks and on the 'inflations bias' of the government, due to the incentive to raise employment above the market-clearing level. Wage indexation will be low if real shocks are large and if the government is inflation-averse. The ability of monetary policy to offset monetary disturbances makes them irrelevant to the determination of the optimal degree of indexing. Copyright 1994 by Ohio State University Press.