RDP 8909: Optimal Wage Indexation, Monetary Policy and the Exchange Rate Regime 6. Summary and Conclusions

The principal findings of this study are:

1. the exchange rate regime is an important determinant, in both theory and practice, of the optimal degree of wage indexation;
2. over the period 1973 to 1988, innovations to nominal wage growth were indexed to innovations in price inflation in the major industrial economies at considerably less than the optimum rate. Thus, the simple explanation that the deterioration of labour market performance can be attributed to excessive wage indexation is not supported by the data;
3. equally, one cannot place the blame for the increase in unemployment on systematically restrictive monetary policy. There is no evidence to suggest that monetary policy persistently lowered the price level relative to the nominal wage, thereby creating an excessively high real wage.

These findings do not, however, necessarily preclude a more subtle role for real wages in the creation of labour market disequilibria. An excess supply of labour can co-exist with the optimal indexation of nominal wages to changes in the price level. This will occur if an adverse shock lowers the equilibrium real wage relative to its actual value and an appropriate adjustment is not made to the real wage level which forms the base for subsequent indexation. Hysteretic effects in the labour market are a possible mechanism by which this shock and its effects are propagated.