Wage-Indexation, Informational Externalities, and Monetary Policy.

This paper proposes a contract theory of wage-price indexation, assuming labor contracts that stipulate labor time and workers' renumeration and an economy subject to real and monetary disturbances. Novel features are the analysis of indexation as a statistical inference problem and the modeling of a contract economy in which the price level may be informative, but which is plagued by informational externalities. Several results differ from the traditional literature. In particular, the authors explain why full indexation occurs under plausible circumstances, why indexation gives rise to a social efficiency problem, and why monetary stabilization improves welfare--despite rational expectations and optimal indexation. Copyright 1991 by Royal Economic Society.