THE MICROFOUNDATIONS OF WAGE INDEXATION
Abstract
Wage indexation is a contract which can protect to varying degrees the real wage received by workers. Indexation has been suggested not only as a means of protecting the real value of nominal variables from fluctuations in prices, but also as a policy tool to insulate the real sector of an economy from economic disturbances. The first chapter discusses the major issues and questions concerning wage indexation. In much of the literature, the degree of indexation is obtained by optimizing some objective function on the macro level. Actual indexation, however, is generally negotiated between a firm and its employees (or a union representing the employees). While all workers may be concerned about their real wages (nominal wages deflated by an index of product prices), the firm's decisions are based on its own product wage. In the second chapter we develop an implicit contract model which is used to determine the extent of wage indexation for a firm and its employees when they are faced with fluctuations in local and aggregate demand. Three separate cases are analyzed. The optimal degree of indexation is shown to depend on the firm's optimizing behavior (i.e., its objective function). Chapter 3 deals with several extensions of the model. The introduction of non-labor income allows us to examine the relationship between wage indexation and financial asset indexation, and wage indexation and the worker's saving behavior. When the individual is indifferent between labor income and non-labor income, wage indexation and financial asset indexation are perfect substitutes. Wage indexation is also shown to depend upon the net worth position of the worker. The effects of unemployment compensation and costs of adjusting the nominal wage on the optimal degree of indexation are also examined. Chapter 4 analyzes the employment decisions of the firm in our implicit contract model. Various comparative static results are obtained which illustrate the effects the parameters of the model have on the levels of employment, the probability of employment and the real wage. Aggregate or local price shocks which reduce the dispersion of relative prices are found to reduce the probability of unemployment for those workers attached to the firm. It is this result which allows us to argue that policies or disturbances which result in an economy-wide increase in the dispersion of relative prices will cause an increase in the natural rate of unemployment.
Degree
Ph.D.
Subject Area
Economics
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