5 Analyzing the estimated model
In the preceding section we have provided definite answers with respect to the type of
real wage effect present in the data of the US economy after World War II, concerning
the dependence of aggregate demand on the real wage and the degrees of wage and
price flexibilities. The resulting combination of effects suggest that it is favorable for
stability. We stress however that the inflation climate is so far only measured by a
moving average of past inflation rates with linearly declining weights. So role of the
parameter βπ - which when increased will destabilize the economy - is thus not yet
present in the considered situation.
We start the stability analysis of the model with estimated parameters in this section
from a basic 3D core situation which we obtain by totally ignoring adjustments in the
inflationary climate term by setting πm = π and by interpreting the law of motion
for Vl in level terms, i.e., by concentrating on the influence of Vc on Vl. Integrating
this relationship gives approximately Vl = +const (V c)0.42 as can also be confirmed by
estimating this level form relationship directly. Under these assumptions, the laws of
motion (1) - (5) can be reduced to:
Vc = const — const Vc — const r — const ω (36)
r = —const + const Vc — const r + const ω (37)
ω = const + const Vc — const ω (38)
We note here that we have inserted here the reduced form expression for the price
inflation rate into the first law of motion for the activity dynamics and rearranged terms
such that the influence of Vc and ω appears only once, though both terms appear via
two channels in this law of motion, one direct channel and one via the price inflation
rate. The result of our estimate of this equation is that the latter channel is not changing
the signs of the direct effects of capacity utilization (via the dynamic multiplier) and the
real wage (via consumption and investment behavior).8
A similar treatment applies to the law of motion for the nominal rate of interest, where
price inflation is again dissolved into its constituent part (in its reduced form expression)
and where again the influence of Vl in this expression is replaced by Vc through Okun’s
Law. Again the direct effect of ω in the Taylor rule is assumed to dominate the indirect
on (via the inflation rate), as this was confirmed by our empirical estimate of this law
of motion.9
Finally, the law of motion for real wages themselves is obtained from the two estimated
structural laws of motion for wage and price inflation in the way shown in section 2. We
have a positive influence of capacity utilization on the growth rate of real wages, since
the wage Phillips curve dominates the outcome here and a negative influence of real
wages on their rate of growth due to the signs of the Blanchard / Katz error correction
terms in the wage and the price dynamics.10
8 to be estimated in this form: sign of βp2 — κpβw2 does not matter?
9 to be estimated in this form: sign of βp2 — κpβw2 does not matter?
10to be estimated in this form: DFP to be suppressed?
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