Wage Indexation and the Cost of Disinflation

While a standard academic presumption has been that wage indexation reduces the cost of disinflation, policymakers generally contend that wage indexing makes disinflation more difficult. To shed light on these views, this paper reexamines the effects of wage indexing on the output loss caused by money-based stabilization. It finds that the cost of disinflation with indexedwage contracts tends to be smaller than that with contracts that specify preset time-varying wages, but larger than that with contracts that specify fixed wages. Thus, the academic and the policymakers' views can both be appropriate depending on the standard of reference.