Reply to Alvin Marty

Olrnegie-Rochester Conference Series on Public Policy 19 (1983) 313-316 North-Holland

REPLY TO ALVIN MARTY

Benjamin

Eden

The University of Iowa

Alvin Marty’s paper focuses on the normative of indexation there

is desirable.

is very little

contracts.

indexation,

focuses

or more generally,

by a Walrasian

Finally,

differences

he uses a different

between

question

auctioneer.

the papers,

than

I would

assumption various

being

shocks,

performs

version

an inelastic

labor

supply.

He then

one shock at a time, and finds that:

as well as indexing

to the money

better

to not indexing

in the case of velocity

supply

But in the case of real shocks indexing

shocks);

not indexing

indexing

that other prices

than analyzing

the

on Alvin Marty’s

supply

subjects indexing

Fortunately,

indexing

goes, indexing

full-information)

supply is equivalent to the price level is a

shocks) and a tie in another

and not indexing

supply

and worse in the case of real

to the money

to the money

to

supply

(the case of

is a tie in two cases and for winning

points,

indexing

at all one point.

and one to the

The obvious

to the price level.

we have a better

the economy to show that

the economy

to the price level

in the case of money

to the price level gets three

gets two points,

choice is, therefore,

is possible

model, the simplifying

at all is a tie in one case. Giving two points

for a tie, indexing

by subjecting

shocks,

at all. Thus, the argument

in one case (the case of velocity

money-supply

(or

I do. Rather

of the Gray-Fischer

shocks,

point

assuming

prices and wages symmetri-

like to comment

shocks.

money

of why

in terms of his model. He uses a simplified

winner

of which form question

very little use of contingent

I treat

model

question

on the positive

He focuses on the issue of wage indexation

are determined cally.

My paper

to all three under

solution

way of weighting shocks

the assumptions if -we link

successes and failures

simultaneously.

In this case, it

made we can get a first-best

wages to MI/,

that

is, to nominal

income. To see this point

we may use Alvin Marty’s result for the case in which

there are only real shocks. In this case fixed nominal wages work perfectly: an increase in productivity increases real GNP and reduces the price level, thus increasing the ex-post real wage. Under the assumptions made it also increases the marginal product of labor by the same percentage. Thus, in the absence of

0 167-2231/83/$03.00

0 1983 Elsevier Science Publishers B.V. (North-Holland)

monetary disturbances to demand. Linking

fixed nominal

wages ensure that ex-post

wages to MV neutralizes

the effect

nominal

change income

Therefore, money

linkage

wages and prices. At the same time,

to nominal

to its behavior

solution,

the same result in the presence In my first paper income

In the absence In the presence an advantage. income

and

availability

of monetary

on the subject

compared

sector: sector

shocks, indexation

if for some reason (which,

in Israel,

that

associated

with random

linkage changes

I am more inclined

or to the price level. Financial innovations

take the view that financial

changes in government do not occur the observed these strated

often

fluctuations

under

in my conference

supply”

(Eden

in velocity alternative

the problem a broader

1979, p. 137). of velocity

supply on indexation

to nominal

of velocity

shocks.

the creation

conditions

of fluctuations

It seems that in most countries

(in this sense the present

fluctuations

overcomes

or for that matter source

GNP

will have to go up. Thus, I

to changes in economic Another

to the

wages go up in the

to play down the importance

innovations,

regulations.

to nominal

50% of GNP), then

are said to be one source

as exogenous.

seems to have

of GNP only with a

strike)

income

to the money

occur in response

be treated

income indexation

I am not sure whether

to the money

shocks and to prefer indexation

new markets,

to nominal in velocity,

supply.

are equivalent.

sector are transmitted

for about sector

indexing

at the time were (a) the

(say a successful accounts

suggest linkage

At present

not

to nominal

wages in the private

“although

not

I discussed

to the money

in Israel one can get good estimates

concluded view would

1979),

indexation

concerns

wages

will produce

1

in implementing

like Israel. My main

and fixed

fixed money income

the two forms of indexation

I saw difficulties

will go up and linked

income

(Eden,

it with

lag, (b) shocks to wages in the public

private

to

of the real wage is

disturbances

disturbances.

of velocity

of data:

public

V

linking

disturbances

wages to nominal

shocks,

in a country

the behavior

of monetary

linking

of velocity However,

considerable

income

in the case of no monetary

wages. Since in the absence

lead to the first-best

to nominal

in M and

allows real shocks to affect real wages in the desired direction.

under

identical

in nominal

of changes

is equal

in M and V leads to an equal

on the real wage, since in this case any change Percentage

supply

time is misleading).

of any

and should in velocity

indexation

schemes,

of indexation

is

such changes In any case,

do not tell us much on the magnitude

paper the method

I

of

since as was demonaffects the magnitude

‘The argument for indexing to nominal income can be made in any model in which, in the absence of monetary disturbances, fiied money wages work. For an alternative model with this property see Eden (1979).

314

of the

so-called

equilibrium, equilibrium velocity

velocity

measured measured

shocks

velocity velocity

In a more

general

is a known

function

the wage rate a function full information

that

fixed-dollar-prices

Nash

while in the contingent-prices

Nash

in the

is constant). model;

in which labor

of income solution.

formula

supply

and interest

of both the money

or first-best

In this case the specific

(recall

fluctuates

is not inelastic

and

rate, one will have to make

supply and the price level to get the

(See Fethke

will depend

and Jackman,

on the elasticities

forthcoming). of the demand

for and the supply of labor and will vary across firms. There tailored

are costs, however,

for the specific

for writing

needs of a particular

judgment,

the simple indexation

short-term

wage and price contracts.

complicated

complicated

contracts

which are

firm. These costs will make, in my

to the money (Long-term

supply

the optimal

contracts

solution

for

may use the more

formula.)

Alvin Marty’s paper also gives the erroneous continuous

government

the money

supply.

This means

that

coordinated

move.

intervention

I argued

if we want

that

impression

which is designed there

indexation

exist two Nash equilibrium

to move to the preferred

The government

that I advocate

to impose

can provide

equilibrium,

the initial

to

solutions. we need a

push, but once all

agents use linked prices there is no need for further intervention. Finally, objective supply,

the issue of an open economy

of neutralizing

the effects

we should link to domestic

is important.

of deficit-induced

credit.

315

If we accept

changes

the

in the money

References Eden, B. (1979)

The Nominal to Nominal

Fethke,

G. and Jackman,

(forthcoming)

Optimal

System: Income,

Linkage

to the Quantity

of Money or

Revue Economique,

30: 121-143.

Policy,

Supply

R. Monetary

Expectations,

Endogenous

and Rational

The Journal of Monetary Economics.

316