Abstract:
This paper shows how economic interdependence affects wage indexation decisions when monetary
authorities do not observe stochastic disturbances. Under a managed exchange rate, atomistic wage
setters in interdependent nations will choose the same degree of indexation as they would in a small
open economy. Under a flexible exchange rate, the likelihood rises that they will choose a lower
degree of indexation than their counterparts in a small open economy as the degree of interdependence
rises, as the variance of money demand shocks rise relative to supply shocks, and as supply curves
steepen. Finally, wage indexation choices are more likely to be strategic complements as the degree
of interdependence rises and as the variance of money demand shocks rises relative to supply shocks.
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