Working Paper
Real and Relative Wage Rigidities

The overlapping wage contract model, known as the staggered contract model, is expanded in an open economy context to include wage indexation to add some more realism to the model. In addition the effects of alternative assumptions about availability of information in wage negotiations are studied. It is shown that in the case of shocks in domestic costs indexation can improve economic stability if demand for the domestic good is price inelastic and wage negotiations are not sensitive to cyclical conditions. This contrasts strongly with static macro models where indexation reinforces the destabilizing power of supply shocks. With respect to shocks in the price of imported inputs, indexation reduces economic stability despite the fact that one could conjecture that indexation increases the responsiveness of wage contracts to shocks that affect domestic output.