Keynesian Dynamics and the Wage-Price Spiral:Estimating a Baseline Disequilibrium Approach

provided by Research Papers in Economics

Keynesian Dynamics and the Wage-Price Spiral.

Estimating a Baseline Disequilibrium Approach *

Carl Chiarella

School of Finance and Economics
University of Technology, Sydney
Australia

Willi Semmler

Faculty of Economics

Bielefeld University, Bielefeld
Germany

May 28, 2004

Abstract:

We reformulate the baseline disequilibrium AS-AD model of Asada, Chen, Chiarella
and Flaschel (2004) to make it applicable for empirical estimation. The model now ex-
hibits a Taylor interest rate rule in the place of an LM curve, a dynamic IS curve and
dynamic employment adjustment. It is based on sticky wages and prices, perfect foresight
of current inflation rates and adaptive expectations concerning the inflation climate in
which the economy is operating. The implied nonlinear 5D model of real markets dise-
quilibrium dynamics avoids striking anomalies of the Neoclassical synthesis (Stage I). It
exhibits Keynesian feedback structures with asymptotic stability of its steady state for
low adjustment speeds and with cyclical loss of stability - by way of Hopf bifurcations -
when certain adjustment speeds are made sufficiently large.

In the second part we estimated the equations of the model to study its stability
features from the empirical point of view with respect to the feedback chains it exhibits.
Based on these estimates we also study to which extent a stronger Blanchard / Katz error
correction mechanism, more pronounced interest rate feedback rules or downward wage
rigidity can stabilize the dynamics in the large when the steady state is found to be locally
repelling. The achievements of this baseline disequilibrium AS-AD model, its Keynesian
feedback channels and our empirical findings can be usefully contrasted with those of the
microfounded, but in scope more limited now fashionable New Keynesian alternative (the
Neoclassical Synthesis, Stage II).

Keywords: DAS-DAD growth, wage and price Phillips curves, estimation, adverse real
wage adjustment, (in)stability, persistent business cycles, monetary policy rules.

JEL CLASSIFICATION SYSTEM: E24, E31, E32.

* Preliminary version. Please do not quote without permission from the authors.

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