Working Paper: NBER ID: w5637
Authors: Boyan Jovanovic; Masako Ueda
Abstract: We analyze the contractual relation between workers and their employers when there is nominal risk. The key feature of the problem is that the consumption deflator is random and observed sometime after the effort is exerted. The worker's effort is not observable, and to induce the agent to work, second-best contracts do not insure the worker fully. They do eliminate all nominal risk for the parties (by fully indexing the terms of the contracts to the price level) but they would be re-negotiated. Foreseeing this, the parties to the contract will write one that is renegotiation-proof. Under such a contract, nominal shocks affect real consumption. Since the argument should apply in many situations, it will have macroeconomic implications, one of which is short-run non-neutrality of money. We have found that surprise money is likely to redistribute consumption and welfare towards workers, and away from shareholders.
Keywords: Contracts; Money; Nominal Risk; Macroeconomic Implications
JEL Codes: E40; E50; J41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nominal contracts (K12) | price-level risk (E30) |
| nominal shocks (E39) | real consumption (D11) |
| nominal shocks (E39) | worker welfare (J38) |
| positive price surprises (E30) | worker's share of output (D33) |
| surprise money shocks (G59) | stock returns (G12) |
| unexpected inflation (E31) | real stock prices (G19) |
| design of contracts (K12) | distribution of welfare between workers and shareholders (D33) |
| nominal rigidity in contracts (D86) | insulation from monetary shocks (E49) |