Working Paper: NBER ID: w1170
Authors: Stephen J. Turnovsky
Abstract: The analysis of this paper stresses the interdependence between wage indexation on the one hand, and exchange market intervention on the other,as tools of'macroeconomic stabilization policy in a small open economy subject to stochastic disturbances. It is shown how the choice of eitherpolicy instrument impinges on the effectiveness of the other. In particular,if the domestic money wage is fully indexed to some weighted average of the domestic and foreign price levels, then irrespective of what that chosen weight may be, exchange market intervention is rendered totally ineffective insofar as the stabilization of the real part of the domestic economy is concerned. Likewise, if the monetary authority intervenes in the exchange market so as to exactly accommodate for nominal movements in the demand for money, thereby rendering the excess demand for money dependent only upon real variables, then any form of wage indexation is totally ineffective for the stabilization of the real part of the system. In either polar case, the respective instrument can stabilize the domestic price level. Alternative combinations of policy for the stabilization for domestic and foreign disturbances are considered.
Keywords: wage indexation; exchange market intervention; small open economy; macroeconomic stabilization
JEL Codes: E31; E42; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic wage indexation to a weighted average of domestic and foreign price levels (C43) | Exchange market intervention becomes ineffective in stabilizing the real economy (F31) |
| Monetary authority intervention in the exchange market accommodating nominal movements in money demand (E49) | Wage indexation becomes ineffective for stabilizing real variables (E31) |
| Exchange market intervention becomes ineffective in stabilizing the real economy (F31) | Indexed wage nullifies the impact of intervention on real variables (E31) |
| Monetary authority intervention results in excess demand for nominal money dependent solely on real variables (E49) | Wage indexation loses its effectiveness in influencing real behavior (J38) |