The author is grateful to the Fulbright-Hays Faculty Research program for financing, to the C. V. Starr Center for Applied Economics for additional funding, and to E. Kleiman and R. Klinov of the Hebrew University, B. Stein of New York University, the members of the Research Department of the Bank of Israel, and a few anonymous referees for their helpful comments on an earlier draft.

¹ Blanchard, O. J., “Wage Indexing Rules and the Behavior of the Economy,” Journal of Political Economy, 87, 4 (08 1979), 798–815;CrossRefGoogle Scholar and Liviatan, N., “On Equilibrium Wage Indexation and Neutrality of Indexation Policy,” in Armela, P. A. et al. , Financial Policies and the World Capital Market: The Problems of Latin American Countries (Chicago, 1983), pp. 107–24, provide alternative explanations for less-than-perfectly indexed contracts. Blanchard posits information costs, while N. Liviatan views capital market linkage as a substitute for total wage linkage.Google Scholar

² Patinkin, D. and Brenner, R., “Indexation in Israel,” in Lundberg, E., ed., Inflation Theory and Anti-Inflation Policy (Boulder, Colo, 1977), pp. 393–94;Google ScholarKleiman, E., “Monetary Correction and Indexation: The Brazilian and Israeli Experience,” Explorations in Economics, 4, 1 (Winter 1977), 144.Google Scholar

³ Wood, G. E. F. and Horowitz, D., Report of the Joint Committee on the Problem of Wage Adjustment (Tel Aviv: The Executive Committee of the General Federation of Jewish Labour in Eretz-Israel [Palestine], 1942). Wood was the chief government statistician, while Horowitz, who later became the first governor of the Bank of Israel, was the economist of the Jewish Agency.Google Scholar

⁴ The retail price index rose 16.9% between 1939 and 1940, and a further 55% between 1940 and 1942. Corresponding numbers for wholesale prices are 24% and 99%. See Szereszewski, R., Essays on the Structure of the Jewish Economy in Palestine and Israel (Jerusalem, 1960), p. 68.Google Scholar

⁵ Indeed, capital market assets were indexed in 1954 as the public's reluctance to lend unlinked led to a sharp reduction in bond sales.

⁶ A survey of the Histadrut structure and activities may be found in Ben-Meir, D. B., The Histadrut (Jerusalem, 1979) (Hebrew). Friedman mentions the generally accepted estimate that 90% of the Israeli labor force is unionized, 90% of that with the Histadrut.Google Scholar See Friedman, A., “Collective Bargaining and Wage Policy During a Period of Runaway Inflation,” Economic Quarterly, 106 (09 1980), 226 (Hebrew).Google Scholar

⁷ For a more comprehensive survey of Israeli labor relations, see Galin, A. and Hard, A., Developments and Trends in [the] Israel Industrial and Labour Relations System (Ramat Gan, 1978) (Hebrew).Google Scholar

⁸ The Committee to Examine Cost of Living Adjustments, Report (Jerusalem, 1975) (Hebrew). (Hereafter, Sussman Committee Report.)Google Scholar

⁹ Gray, J. A., “Wage Indexation: A Macroeconomic Approach,” Journal of Monetary Economics, 2, 2 (04 1976), 221–35;CrossRefGoogle Scholar and Fischer, S., “Wage Indexation and Macroeconomic Stability,” Journal of Monetary Economics, 5 (1977), Supplement, 107–48.Google Scholar

¹⁰ Committee of Experts to Investigate Indexation, Report (mimeo, 1966) (Hebrew).Google Scholar

¹¹ Sussman Committee Report, p. 1 (author's translation).

¹² Since in this case w_n = w_b(l + p), then w_n ≠ (1 + p) = w_b, the initial nominal and real wage.

¹³ Since w_n = w_b(l + αp)¹, and w_n = w_b(l + p)¹, then for a given p, the time in which the two functions are equal for any given initial basic wage and indexation ration is derived from t = (ŵ_b − ŵ_b) / [(1 + p) − (1 + αp)] the hats representing logarithmic values. Whether TT will be convex or concave to the origin hinges on the attitude toward inflation risk by both employers and employees. If both are risk averse, TT will be concave, the degree of concavity depending on the relative degree of risk aversion. If employees are risk averse while employers are risk-takers, TT will take a convex shape. For a more formal analysis of the role of risk in the indexing decision, see Ehrenberg, R. E., Danziger, L., and San, G., “Cost-of-Living-Adjustment Clauses in Union Contracts: A Summary of Results,” Journal of Labor Economics, 1, 3 (07 1983), 215–45, especially 221–24.CrossRefGoogle Scholar

¹⁴ For example, Gray, “Wage Indexation” Okun, A., “The Mirage of Steady Inflation,” Brookings Papers on Economic Activity, 2, 1971, pp. 485–98;CrossRefGoogle ScholarBernstein, E. M., “Indexing Money Payments in a Large and Prolonged Inflation,” in Giersch, H. et al. , Essays on Inflation and Indexation (Washington, 1974), pp. 71–86.Google Scholar

¹⁵ For example, H. Giersch, “Index Clauses and the Fight Against Inflation,” and M. Friedman, “Monetary Correction,” in Giersch, et al., Essays, pp. 1–16 and 25–46, respectively; Scheifer, V. J., “Cost-of-Living Adjustments: Keeping up with Inflation,” Monthly Labor Review, 102, 6 (06 1979), 14–17;Google ScholarZalisky, J., “Cost-of-Living Clauses: Always Playing Catch-Up,” in Adelman, R., ed., Proceedings of New York University Thirty-Third Annual Conference on Labor (New York, 1981), pp. 195–210;Google Scholar and Griffiths, B., Inflation: The Price of Prosperity (New York, 1976), Ch. 12.Google Scholar

¹⁶ Gray and Fischer's implication that partial linkage will inhibit cost-push inflation assumes that employees will not successfully negotiate a large compensating growth in basic wages.

¹⁷ Goldstein, M., “Wage Indexation, Inflation, and the Labor Market,” IMF Staff Papers, 22 (11 1975), 682.Google Scholar

¹⁸ Findling's calculations (in Y. Findling, “The Development of the COLA [in Israel],” Hebrew University seminar paper, undated [Hebrew]) based on ceiling wages, show periods during the 1950s without any erosion, but a declining share of real income covered by the COLA in later periods. By 1974, Findling found that approximately two-thirds of the wage had been washed away by inflation (pp. 17–18). However, his data exaggerate the impact of the decline in real wages, since the ceiling wage was never an effective tool for holding down real earnings. Liviatan (in O. Liviatan, “The Development of the COLA and a Test of the Frequency of Wage Adjustments to Prices,” Bank of Israel Research Department Discussion Paper 9–82 [Hebrew]), using average wages, found that the rate of compensation between 1957 and 1974 never declined below 91% of the rise in the CPI (p. 120).

¹⁹ The Committee also claimed that a 30% margin would inhibit a wage—price spiral deriving from both cost-push elements and government anti-inflationary indirect tax policy, and that partial indexation would buy time for those firms whose prices rose less than CPI, allowing them to adjust gradually to changing-relative prices and thus limit involuntary unemployment (Sussman Committee Report, pp. 9–10): See also Dror, D. M., “Flexible Indeation: A proposal to improve wage indexation made in the light of Israeli experience,” International Labor Review, 120, 2 (03–04 1981), 183–200.Google Scholar

²⁰ Liviatan, O., “Development of the COLA,” p. 12. A similar pattern is reported in the Institute for the Study of Output and Income, Report on Output and Income, 1981 (February 1982; Hebrew), 8, Table 5, but the absolute degree of compensation obtained from the COLA is lower than Liviatan's estimates.Google Scholar

²¹ Liviatan, O., “Development of the COLA,” pp. 5–6.Google Scholar

²² Ibid., p. 29.

²³ Although an increase in labor's share of national product is implied by Table 2, this did not come at the expense of profits. Anecdotal evidence indicates that employers profited significantly from the virtually continuous and, since 1967–1969, accelerating inflation. More suggestive is the steep decline in the real tax burden of Israelis since 1970. From a value of 100 in 1970, the tax burden declined to 40 in 1981 (Bank of Israel, Annual Report, 1982 [Hebrew], 97). Undoubtedly, employers as well as employees benefited.Google Scholar

²⁴ Patinkin and Brenner, “Indexation,” p. 395; Sussman, Z., “The Wage Policy of the Histadrut—Its Effects on Israel's Economy,” in Avrech, I. and Giladi, D., eds., Labor and Society in Israel (Tel Aviv, 1973), pp. 64–65;Google Scholar Sussman Committee Report, p. 10; Liviatan, O., “Development of the COLA,” pp. 2, 7.Google Scholar

²⁵ Card, D., “Cost-of-Living Escalations in Major Union Contracts, Industrial and Labor Relations Review, 37, 1 (10 1983), 42, hypothesizes in passing such motivation for union leaders, but does not discuss the advantages obtained by employers.CrossRefGoogle Scholar

²⁶ In general it seems puzzling that union members were satisfied with ex post COLA protection, never recouping the wage erosion of the previous period. The single-stage model suggests that projected inflation is discounted in advance.