Indexation, Deficit Finance and the Inflationary Process

Abstract

Two common perceptions regarding indexation are that it is inflationary and that because indexation reduces the redistributional (and other) costs of inflation, the willingness of the authorities to halt inflation is diluted in an indexed economy by comparison with one that is non-indexed. However, these propositions have received surprisingly little attention in the formal literature for any form of indexation other than wage indexation. If the only form of indexation present in an economy is wage indexation, then it is well-known from the familiar Fischer [4] and Gray [6] analysis, that wage indexation exacerbates the price level increasing effects of inflationary disturbances (subject to the qualifications noted by Barro [1] and Cukierman [3]), while the impact of the latter upon real output and employment depends upon the source of the disturbance. None of these papers however, consider the implications of any other form of indexation other than wage indexation. Thus, there is virtually no work on the interaction of alternative types of indexation with deficit finance, in determining the inflationary course of an economy, nor any discussion of how such indexation is likely to impinge upon the macroeconomic effects (such as those on the price level, the interest rate or on the government budget deficit) of underlying inflationary innovations in the economy. While several countries have formal wage indexation arrangements, as least five countries (Argentina, Brazil, France, Iceland and Israel) have had indexed government bonds. In addition, social security payments (government transfers) are indexed to the price level in most countries (including some that do not have wage indexation on any large scale, such as West Germany, Portugal, Spain and Sweden) and finally, some countries have also experimented with indexation of income tax collections (Argentina, Austria, Brazil, Canada,