Working Paper: CEPR ID: DP2616
Authors: Patrick Minford; Eric Nowell
Abstract: A representative agent who is employed chooses an optimal degree of wage indexation (to prices and the auction wage) in response to the monetary regime. Should that regime target the growth rate or the level of the money supply, or of prices (as in a commodity standard)? We find that, contrary to the usual finding from macroeconomic models with fixed wage contract structures, there are gains in welfare for the average household, with both real wages and employment being stabilized. The reason is that when the monetary regime shifts to targeting levels, indexation falls markedly; this flattens the aggregate supply curve and steepens the aggregate demand curve, providing a high degree of ?automatic? stabilization. The choice between targeting money or prices creates a trade-off between employment and real wage stability-implying a distributional conflict between insiders and outsiders in the labour market.
Keywords: inflation targeting; interest rate setting; monetary rules; price-level targeting
JEL Codes: E00; E50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary regime targeting money supply or prices (E52) | Wage indexation decreases (J39) |
| Wage indexation decreases (J39) | Flattening of aggregate supply curve (E23) |
| Wage indexation decreases (J39) | Steepening of aggregate demand curve (E00) |
| Flattening of aggregate supply curve and steepening of aggregate demand curve (E00) | Greater automatic stabilization (E63) |
| Wage indexation decreases (J39) | Lower volatility of real wages and employment (J39) |
| Shift from targeting money supply growth to its level (E49) | Reduced persistence of shocks (E32) |
| Reduced persistence of shocks (E32) | Stabilized economic conditions (E63) |
| Greater automatic stabilization (E63) | Welfare gains for average households (D69) |
| Greater automatic stabilization (E63) | Distributional effects favoring insiders over outsiders in the labor market (J79) |