Limited Nominal Indexation of Optimal Financial Contracts
We study a model with repeated moral hazard where financial contracts are not fully indexed to inflation because nominal prices are observed with delay, as in Jovanovic and Ueda (1997). More constrained firms sign contracts that are less indexed to inflation, and as a result, their investment is more sensitive to nominal price shocks. We also find that the overall degree of nominal indexation increases with uncertainty in the price level. An implication of this is that economies with higher inflation uncertainty are less vulnerable to a price shock of a given magnitude, that is, aggregate investment and output respond to a lesser degree.