Nominal budgeting as a stabilization rule: The optimal degree of indexation of public spending

We analyze here a novel instrument of fiscal policy, the degree of adjustment of public spending to price surprises. This acts as an automatic stabilizer which fully substitutes for wage indexation. Partial reliance on nominal budgeting is usually optimal, in contrast to the conventional assumption of pegged real government spending. Unlike what emerges in the wage indexation literature, we show that the more pronounced is the relative importance of demand shocks, the stronger is the case for lack of indexed public spending. We find that a low degree of wage indexation may be the optimal response to government budgets not cast in real terms.