Legal Definition of Indexation a device for controlling inflation
S J Tubrazy
Indexation is a system of relating income, especially from investment, to the retail price index in a time of inflation in order to offset the fall in the value of money.
Economic variables are indexed to maintain the real value of variables which are measured in money units. The technique is to link a variable with a selected index e.g. wages may be linked to retail price index. The object is to prevent the erosion of real wages irrespective of changes in the price level. Similarly, the rate of interest can be indexed so that positive rate of return on money can be protected in real terms. Tax system constitutes an important area of indexation so that the proportion of deducted earnings can be kept relatively constant over time”. (K.K. Dewett: Modern Economic Theory, ed. 83, Karachi, p.448).
Indexation may be feasible in respect of wages, salaries and pensions to a mild extent as a temporary sedative for the pain of inflation. But “it is difficult to see how a just case could be built for the indexation of financial assets. Since investors (who not only save but also take the risk of investment) are not assured of a stable real value of their investments, why should savers and cash holders be so assured when they don’t even take the risk. Instead of introducing inequities through indexation it would be just to ask the holders of cash to seek protection through investment. Indexation would tend to induce savers to shy away from risk capital which has been emphasized in the Islamic value system and which is necessary for a growing economy. It would hence be desirable to induce savers to offset any erosion in the real value of their savings through investment”. (M. Umar Chapra, Towards a Just Monetary System, Leicester Edition, p.40).
Economists have considerably elaborated the merits and demerits of indexation and it clearly appears from the study of the relevant material that the demerits of the theory surpass greatly than that of its merits. Anyhow, indexation has not been considered a cure for inflation, rather it tends to perpetuate and accelerate inflation and to be self-defeating.