Description

The objective of this paper is to examine the relation between automatic price and salary indexation and the cost of reducing inflation. The analysis complements previous work done by Ball (1994, 1995), Bonomo and García (1995) and Jadresic (1995, 1996), but with an emphasis on the consequences of the frequency of indexation, and other characteristics of labor contracts, on the sacrifice coefficient. Calvo's (1983) supply equation is extended to include automatic readjustability clauses relating to past inflation, and responses of the economy to various monetary stabilization experiments are simulated. The results suggest that indexation introduces inertia in the inflationary process and therefore increases the sacrifice coefficient. Interestingly, the relation between the frequency of indexation and the cost of stabilization is not monotonic. A greater indexation frequency can reduce de sacrifice coefficient. The examples studied suggest that with biannual wage contracts, the typical structure observed in Chile, the sacrifice coefficient is maximized with six-month readjustment frequency, the typical frequency observed in Chile.