DP2616 | Optimal Monetary Policy with Endogenous Contracts: Should we Return to a Commodity Standard?

Publication Date

28/11/2000

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Abstract

A representative agent who is employed chooses an optimal degree of wage indexation (to prices and the auction wage) in response to the monetary regime. Should that regime target the growth rate or the level of the money supply, or of prices (as in a commodity standard)? We find that, contrary to the usual finding from macroeconomic models with fixed wage contract structures, there are gains in welfare for the average household, with both real wages and employment being stabilized. The reason is that when the monetary regime shifts to targeting levels, indexation falls markedly; this flattens the aggregate supply curve and steepens the aggregate demand curve, providing a high degree of ?automatic? stabilization. The choice between targeting money or prices creates a trade-off between employment and real wage stability-implying a distributional conflict between insiders and outsiders in the labour market.