Indexed unit of account
Encyclopedia
When an indexed unit of account is used in contracts, payments are indexed to the price level
in such a way that changes in the inflation rate have no effect on the real value of payments. Non-indexed units, such as contracts written in currency units, incur inflation risk. In periods of unexpectedly high inflation, the debtor is required to pay less in real terms than what both the debtor and creditor agreed to. On the other hand, in periods of unexpectedly low inflation, the debtor is required to pay more in real terms than the agreed value. Contracts in indexed units of account incur no inflation risk, as the real value of payments remains constant.
Indexation is typically achieved by adjusting payments using a consumer price index
. An indexed unit of account, called the Unidad de Fomento
was introduced in Chile in 1967, but it was only in the early 1980s that it was widely adopted by both the Chilean people and the Chilean government. By 1983, over 60 percent of total bank loans in Chile were written in the UF. The value of the UF in pesos is published daily in all major Chilean newspapers and on government websites. Initial doubts about the Chilean governments ability to adopted inflation targeting under such an indexed financial system proved unfounded as the Bank of Chile has successfully maintained low inflation rates since 1998.
In 1848, John Stuart Mill
discusses the inflation risk of non-indexed units of accounts. He states that "All variations in the value of the circulating medium are mischievous: they disturb existing contracts and expectations, and the liability to such changes renders every pecuniary engagement of long date entirely precarious." In 1887 William Stanley Jevons
refers to previous authors and discusses an indexed unit of account which he calls a "tabular standard of value". In 1887 Alfred Marshall
, also referring to previous authors, discusses a similar proposal. In 2003 Robert Shiller
similarly argues for the introduction of an indexed unit of account into the United States economy as a means of eliminating inflation risk.
Price level
A price level is a hypothetical measure of overall prices for some set of goods and services, in a given region during a given interval, normalized relative to some base set...
in such a way that changes in the inflation rate have no effect on the real value of payments. Non-indexed units, such as contracts written in currency units, incur inflation risk. In periods of unexpectedly high inflation, the debtor is required to pay less in real terms than what both the debtor and creditor agreed to. On the other hand, in periods of unexpectedly low inflation, the debtor is required to pay more in real terms than the agreed value. Contracts in indexed units of account incur no inflation risk, as the real value of payments remains constant.
Indexation is typically achieved by adjusting payments using a consumer price index
Consumer price index
A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...
. An indexed unit of account, called the Unidad de Fomento
Unidad de Fomento
The Unidad de Fomento is a Unit of account that is used in Chile. The exchange rate between the UF and the Chilean peso is now constantly adjusted to inflation so that the value of the Unidad de Fomento remains constant on a daily basis during low inflation...
was introduced in Chile in 1967, but it was only in the early 1980s that it was widely adopted by both the Chilean people and the Chilean government. By 1983, over 60 percent of total bank loans in Chile were written in the UF. The value of the UF in pesos is published daily in all major Chilean newspapers and on government websites. Initial doubts about the Chilean governments ability to adopted inflation targeting under such an indexed financial system proved unfounded as the Bank of Chile has successfully maintained low inflation rates since 1998.
In 1848, John Stuart Mill
John Stuart Mill
John Stuart Mill was a British philosopher, economist and civil servant. An influential contributor to social theory, political theory, and political economy, his conception of liberty justified the freedom of the individual in opposition to unlimited state control. He was a proponent of...
discusses the inflation risk of non-indexed units of accounts. He states that "All variations in the value of the circulating medium are mischievous: they disturb existing contracts and expectations, and the liability to such changes renders every pecuniary engagement of long date entirely precarious." In 1887 William Stanley Jevons
William Stanley Jevons
William Stanley Jevons was a British economist and logician.Irving Fisher described his book The Theory of Political Economy as beginning the mathematical method in economics. It made the case that economics as a science concerned with quantities is necessarily mathematical...
refers to previous authors and discusses an indexed unit of account which he calls a "tabular standard of value". In 1887 Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...
, also referring to previous authors, discusses a similar proposal. In 2003 Robert Shiller
Robert Shiller
Robert James "Bob" Shiller is an American economist, academic, and best-selling author. He currently serves as the Arthur M. Okun Professor of Economics at Yale University and is a Fellow at the Yale International Center for Finance, Yale School of Management...
similarly argues for the introduction of an indexed unit of account into the United States economy as a means of eliminating inflation risk.