Nominal Contracts Research Articles

Thrift stock returns and portfolio interest rate sensitivity

In practice, the interest rate sensitivity of depository institution (DI) net worth is measured in terms of maturity mismatches arising from nominal contracts in their financial portfolios. Academic studies also frequently invoke nominal contracting to explain a positive covariation observed between DI stock returns and bond returns. For a sample of thrifts reporting detailed financial data (1984–1992), this study estimates monthly changes in their financial portfolio values due to changes in interest rates. These portfolio value changes are found to be unimportant in explaining the thrifts' stock returns and are unable to account for a positive covariation between the stock returns and bond market returns. Potential weaknesses in the tests seem inadequate to explain the results. Explanations other than nominal contracting may warrant more consideration in relating DIs' net worth to interest rate changes.

A new theory of corporatism and wage setting

The standard view on corporatist institutions for wage setting in many European economies is based of the insider-outsider model. Corporatism is associated with lack of wage flexibility. This paper discusses a new approach starting from the importance of nominal contracts. The rationale for these contracts is to avoid future bargaining. Adjusting these contracts ex post to aggregate shocks would raise their efficiency. However, avoiding the bargaining required for this adjustment was the main reason for negotiating these contracts in the first place. This is the fundamental contradiction. Under corporatism, outside institutions can play this role. These institutions provide therefore a type of flexibility not available in decentralized economies. Empirical evidence supports the basic ideas of this model.

The Debasement Puzzle: An Essay on Medieval Monetary History

We establish several facts about medieval monetary debasements: they were followed by unusually large minting volumes and by increased seigniorage; old and new coins circulated concurrently; and, at least some of the time, coins were valued by weight. These facts constitute a puzzle because debasements provide no additional inducements to bring coins to the mint. On theoretical and empirical grounds, we reject explanations based on by-tale circulation, nominal contracts, and sluggish price adjustment. We conclude that debasements pose a challenge to monetary economics.

The Labor Market and Economic Adjustment

This paper examines the role of the labor market in the transmission process of adjustment policies in developing countries. It begins by reviewing the recent evidence regarding the functioning of these markets. It then studies the implications of wage inertia, nominal contracts, labor market segmentation, and impediments to labor mobility for stabilization policies. The effect of labor market reforms on economic flexibility and the channels through which labor market imperfections alter the effects of structural adjustment measures are discussed next. The last part of the paper identifies a variety of issues that may require further investigation, such as the link between changes in relative wages and the distributional effects of adjustment policies.

Unexpected Inflation and Stock Returns Revisited--Evidence from Israel

This paper examines the effects of unexpected inflation on stock prices using Israeli data that provide a direct market-based measure of unexpected inflation: the price reaction of CPI-linked bonds following the CPI announcement. The results show that stock prices have a strong negative relationship with unexpected inflation. The Israeli setting rules out a number of hypotheses advanced in the United States to explain this relationship, such as nominal contracting, inflationary taxation, wealth transfer, and money illusion. This suggests that the negative effect of unexpected inflation is due to its negative association with real activity and its real economic cost. Copyright 1996 by Ohio State University Press.

Other people's money: Cash-in-advance microfoundations for optimal currency areas

In the traditional theory of optimal currency areas, there are potential gains for stabilization policy with an independent exchange rate and money because rigidity of prices causes an inadequate response of relative prices to shocks. Recent empirical work using modern extensions of the Mundell-Fleming model based on nominal contracts has supported this view. This paper examines whether there is support for it in a (‘classical’) representative-agent model of linked open economies, and finds that there is. The result comes from the cash-in-advance constraint under which the household faces an inevitable delay between working (receiving cash) and being able to spend the proceeds. This delay is the cash-in-advance analogue of the ‘nominal (price) rigidity’ in the optimal currency area models

Speculative bubbles, speculative attacks, and policy switching : Robert P. Flood and Peter M. Garber. Cambridge, MA: The MIT Press, 1994. 493 pp. $50.00 ISBN 0-262-06169-4

Part 1 Speculative bubbles: market fundamentals versus price-level bubbles - the first tests, Robert P. Flood and Peter M. Garber famous first bubbles, Peter M. Garber tulipmania, Peter M. Garber on testing for speculative bubbles, Robert P. Flood and Robert J. Hodrick an evaluation of recent evidence on stock market bubbles, Robert P. Flood et al asset price volatility, bubbles, and process switching, Robert P. Flood and Robert J. Hodrick on the equivalence of solutions in rational expectations Models, Edwin Burmeister et al multi-country tests for price-level bubbles, Robert P. Flood et al. Part 2 Speculative attacks: collapsing exchange-rate regimes, Robert P. Flood and Peter M. Garber gold monetization and gold discipline, Robert P. Flood and Peter M. Garber recurrent devaluation and speculative attacks on the Mexican peso, Herminio Blanco and Peter M. Garber the Belmont-Morgan Syndicate as an optimal investment banking contract , Peter M. Garber and Vittorio U. Grilli real aspects of exchange-rate regime choice with collapsing fixed rates, Robert P. Flood and Robert J. Hodrick exchange-rate regimes in transition - Italy 1974, Robert P. Flood and Nancy P. Marion the linkage between speculative attack and target zone models of exchange rates - some extended results, Robert P. Flood and Peter M. Garber. Part 3 Policy switching: a model of stochastic process switching, Robert P. Flood and Peter M. Garber an economic theory of monetary reform, Robert P. Flood and Peter M. Garber process consistency and monetary reform - some further evidence, Robert P. Flood and Peter M. Garber nominal contracts in a bimetallic standard, Peter M. Garber monetary policy strategies, Robert P. Flood and Peter Isard transition from inflation to price stability, Peter M. Garber comment on bringing down inflation, Robert P. Flood.

The business cycle with nominal contracts

In this paper we study the quantitative implications of nominal wage contracts for business cycle fluctuations. We address this issue using a model economy based on the neoclassical growth model supplemented by the assumption that cash is needed to purchase goods. We consider a variation of the standard recursive competitive equilibrium concept that is intended to capture the important features of wage contracting. We use this equilibrium construct to address three issues. First, we consider whether monetary shocks, propagated by nominal contracts, constitute a viable alternative to technology shocks as a source of aggregate fluctuations. Our results suggest that, while monetary shocks and nominal rigidities succeed in causing output volatility of the required magnitude, the resulting data have properties that are inconsistent with several key features of U.S. data. Second, we consider how the behavior of the economy varies with contract length. We find that the volatility induced by both monetary and technology shocks increases sharply with contract length. Finally we consider how much rigidity would be necessary to match the volatility of U.S. output. We find that only a very small amount of rigidity would be necessary to cause output volatility of the magnitude observed.

The Labor Market and Economic Adjustment

This paper examines the role of the labor market in the transmission process of adjustment policies in developing countries. It begins by reviewing the recent evidence regarding the functioning of these markets. It then studies the implications of wage inertia, nominal contracts, labor market segmentation, and impediments to labor mobility for stabilization policies. The effect of labor market reforms on economic flexibility and the channels through which labor market imperfections alter the effects of structural adjustment measures are discussed next. The last part of the paper identifies a variety of issues that may require further investigation, such as the link between changes in relative wages and the distributional effects of adjustment policies.

Wage Contracts, Capital Mobility, and Macroeconomic Policy

This paper examines the long-run effects of macroeconomic policy shocks on the behavior of output, inflation, real wages and the real exchange rate in a small open economy. The analysis is based on a two-sector, three-good optimizing model with imperfect capital mobility, nominal wage contracts with backward- or forward-looking price expectations, and endogenous mark-up pricing in the nontraded goods sector. The effects of a cut in government spending on nontraded goods are shown to be independent of the expectational mechanism embedded in wage contracts. A reduction in the nominal devaluation rate lowers steady-state output in the tradable sector under backward-looking contracts, but exerts an expansionary effect under forward-looking contracts.

The Determination of Contract Wages in West Germany

The determination of contract wages in West Germany is studied within a bargaining framework, taking into account some institutional features of the bargaining system as well as the influence of economic forecasts and wage concepts. Cointegration regressions suggest that in the long run nominal contract wages are linked to prices, productivity (each with a unit elasticity) and unemployment. In addition to these factors, expectational errors concerning the inflation rate during the contract period and changes in the tax wedge affect (real) wage growth in the short run, but these effects seem to be temporary rather than permanent.

Coordination Failure, Multiple Equilibria and Economic Institutions

Models of coordination failure have equilibria that are not first-best because of externalities. Usually these models display multiple equilibria. We provide an example of how the existence of some economic institutions and government policies can be explained as mechanisms for internalizing externalities and selecting the best equilibrium in these settings. The example we analyse is that of nominal wage and debt contracts. Nominal contracts can improve on the underinvestment equilibrium by implementing Pareto-improving transfers between agents. If there are multiple underinvestment equilibria, then monetary policy can have real effects because the monetary authority can choose a money supply rule to coordinate beliefs and, thereby, select the best equilibrium.

Money and the Business Cycle with One-Period Nominal Contracts

A modified version of the nominal contract developed by J. A. Gray (1976) and S. Fischer (1977) is introduced in a general equilibrium model with money which has been used in the real business-cycle literature. Money is introduced in the model through cash-in-advance constraint. Two kinds of contracts are examined, namely, a nominal wage contract and a nominal price contract. The nominal wage contract improves the fit of the model in many respects. The nominal price contract increases the output volatility enormously but it has some unrealistic features.

International monetary policy cooperation in economies with centralized wage setting

We consider a standard two-country monetary policy game with fixed nominal wage contracts. The policy regime is either non-cooperative or cooperative. We extend conventional analyses by deriving the natural rate of employment endogenously through monopoly union decision-making. As unions attempt to affect the real exchange rate, wages are set inefficiently high. Such attempts are shown to be strongest under monetary cooperation. Therefore, in comparison with non-cooperation, employment is lowest, and, in effect, consumer price inflation is highest, under monetary cooperation, i.e., international monetary cooperation is disadvantageous.

Discretionary Monetary Policy and Socially Efficient Wage Indexation

It is not uncommon for policy-makers, especially when they are trying to reduce inflation, to create incentives or restrictions that change individual decisions regarding nominal wage indexation. This raises a very interesting question for economists: if indexation of nominal contracts is the result of utility-maximizing behavior, why would policy-makers try to alter private indexation decisions? The usual rationale for governmental involvement in markets provided by microeconomic theory is that individual decisions may cause externalities that create a conflict between individual and social optima. Extending this logic to the case of indexation suggests that private indexation decisions may create an inflation externality and, thus, are not socially efficient. Blanchard [1979] and Ball [1988] have investigated the social efficiency of private decisions to index to the price level. They find that the equilibrium degree of wage indexation to the price level is socially inefficient if indexation to other relevant variables is costly. Since indexation costs do not appear to be empirically significant, these models do not provide a very convincing argument for governmental involvement in the indexation process. Furthermore, these models do not tie the degree of indexation to the trend inflation rate, which seems to be the crucial element for justifying governmental intervention. Thus, in order to pinpoint the exact nature of this externality, a model is required that considers endogenous wage indexation but links indexation to the trend inflation rate. Devereux [1987, 1989] uses such a model to examine the relationship between indexation and mean inflation. By combining a Gray [1976] indexation model with a Barro-Gordon [1983] inflation model, he shows that wage indexation affects the mean inflation rate, but he does not address the issue of indexation efficiency. In this paper we use a synthesis of Ball and Devereux's models to demonstrate that individual indexation decisions are, in general, socially inefficient. However, in contrast to Blanchard and Ball's

Tests of the nominal contracting hypothesis using stocks and bonds of the same firms

We test the nominal contracting hypothesis by examining the price responses of stocks and long-term bonds issued by the same firms to inflation surprises. We fail to find evidence that unexpected inflation transfers wealth to real from nominal contract holders, i.e., to stockholders from bondholders. An alternative interpretation of previous tests that seemingly support the nominal contracting hypothesis is proposed, based on firms' asset rather than liability structures. Our test results and alternative interpretation suggest caution in ascribing to nominal contracts major intrafirm wealth redistributions due to unexpected inflation.

Sticky Prices, Money, and Business Fluctuations

Can nominal contracts create monetary nonneutrality if they arise endogenously in general equilibrium? Yes, if (1) agents have complete information about the money stock and (2) shocks to the system are purely redistributive and private information, precluding conventional insurance markets. Without contracts, money is neutral toward aggregate quantities. However, risk-sharing between suppliers and demanders creates an incentive for both parties to use nominal contracts. in particular, if an increase in the money growth rate signals a rise in the dispersion of shocks to demanders' wealth, then prices adjust only partially to monetary shocks and money is positively associated with output.

Is Probability Theory Relevant for Uncertainty? A Post Keynesian Perspective

Mainstream perspectives involving uncertainty presume that expectations are based on either a statistical analysis of past data, with market signals providing information about objective probabilities, or on subjective perceptions of these probabilities founded on the axioms of expected utility theory. Post Keynesians, following Keynes, have developed a different perspective, where probability distributions are not the basis for comprehending real world behavior under uncertainty. According to this analysis, there are many important situations where “true” uncertainty exists regarding future consequences of today's choices. Whenever conditions of true uncertainty prevail, human behavior may differ systematically from what is implied by the standard expected utility perspective. This paper explains how the Post Keynesian perspective differs from the orthodox probability theory approach, thereby providing a more general theory which can explain long-run decisions regarding liquidity demands, investment decisions, the existence of long period underemployment equilibrium, the long-run nonneutrality of money, and the unique and important role Keynes assigned to nominal contracts and especially the money wage contract.

Market power and exchange rate adjustment in the presence of quotas

This paper compares the adjustment of prices, exchange rates, and production across a quota and a tariff regime. We study the factors determining the behavior of the quota rent and the ‘pass-through’ of exchange rate adjustment to the domestic prices of importable goods in a ‘semi-small’ economy characterized by monopolistic competitive market structure and short-run nominal contracts under a floating exchange rate regime. We demonstrate that the pass-through is determined by commercial policy, by the market power of the various producers and by the marginal propensity to consume out of transitory income.

A Model of Nominal Contracts

A model is produced in which labor contracts that prespecify (unindexed) nominal wage payments arise endogenously. These contracts function as a self-selection mechanism. Under appropriately different attitudes toward price-level risk (which can either arise directly from preferences or be induced by different patterns of asset holdings), nominal contracts allow high-productivity workers to signal their type by their willingness to accept unindexed contracts. This explanation of nominal contracts does not require that money be used in any particular set of transactions, and nominal contracts enhance the risk faced by all parties accepting them.