Incomes policies in an open flexprice and fixprice economy

Abstract

Incomes policies have been increasingly called for as Western economies have experienced periods of stag-flation. Part of the attraction of incomes policies has been based on the belief that they are an appropriate instrument to deal with a country's unsatisfactory balance-of-payments position. The purpose of this paper is to evaluate the appropriateness of an incomes policy in an open economy. An optimally structured incomes policy, derived for a simple inflation model, is examined under alternative exchange rate regimes. The model, in the tradition of models by Gordon, Hicks and Okun, is characterized by two output markets, one a flexible price market and one characterized by markup pricing, and a single labor (input) market. This model is then used as the constraint set in a dynamic optimization problem. Both analytical and simulation results are presented. The results suggest that a direct price control program is not appropriate in an open economy.