Indexing and Inflation

Much of the opposition to indexation as a means of adapting to on going inflation arises from the view that indexation is itself inflationary. This paper examines the basis for that view in a simple macroeconomic model in which budget deficits are in part financed through the printing of money. It is shown that all aspects of indexing -- wage indexation, bond indexation, and tax indexation -- tend to increase the impact on the price level of any inflationary shock. However, this association between indexation and inflation is in large part a consequence of the monetary and fiscal policies being followed by the government. Evidence from a cross-section of forty countries on the effects of indexation on the inflationary impact of the oil price shock of 1974 suggests that indexation did not in general increase the inflationary impact of the oil shock. However, the impact of the oil shock was significantly stronger in those countries that had adopted bond indexation.