Wage Indexation, Central Bank Independence and the Cost of Disinflation

Working Papers of BETA from Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg

Abstract: Recently, Fischer [1996] and Posen [1998] demonstrated empirically that countries with less independent central banks enjoy lower output losses during disinflationary cycles. Since independence is presume to provide a credibility bonus to the monetary policy, this conclusion looks surprising. To explain their paradoxical result, these authors put forward that independent central banks probably face a flatter short-run Phillips curve. In this paper, we provide a formal demonstration of this point. More precisely, we demonstrate that the private sector has less incentive to index its nominal wages when the central bank is granted with a large amount of independence. Since an increased indexation steepens the short-run Phillips curve, our result is consistent with the view that where central bank independence is greater, the cost of disinflation is higher. Our empirical tests, for a sample of 19 OECD countries, support our theoretical analysis. In particular, a negative and significant relationship is found between indexation and independence.

Keywords: Central bank independence; indexation; sacrifice ratio (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Date: 2000
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Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:ulp:sbbeta:2000-03

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