| Summary: | This Selected Issues paper summarizes the recent literature on the effects of automatic indexation of wages on the economy, including specifically in Luxembourg. It discusses potential pitfalls of the current system and explores some policy options to tackle them and make the system more resilient. With inflation pressure heightening in 2022, applying the mechanism would have entailed several rounds of indexation in a short time span, potentially harming competitiveness. The note discusses conjunctural concerns, drawing on the extensive literature about the cyclical properties of automatic wage indexation (AWI) schemes and the recent decisions taken by the Government to mitigate wage-price spiral and competitiveness risks by transferring some of the cost to public finances. Structural issues with AWI are explored in the context of long-term productivity and real wage trends at the sectoral level. Luxembourg’s practical implementation of the automatic wage indexation hinges on the availability of political will and could erode the country’s fiscal space
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