foresight coupled with a solution method that avoids all potential instabilities of macro-
dynamic economic systems by assumption. In the present context, this approach would
impose the condition that prices - and also nominal wages - must be allowed to jump
in a particular way in order to establish by assumption the stability of the investigated
dynamics.
By contrast, our alternative approach - which allows for sluggish wage as well as price
adjustment and also for certain economic climate variables, representing the medium-
run evolution of inflation (and in Asada, Chen, Chiarella and Flaschel (2004) also excess
profitability) - completely bypasses such stability assumptions. Instead it allows to
demonstrate in a detailed way, guided by the intuition behind important macroeconomic
feedback channels, local asymptotic stability under certain plausible assumptions (indeed
very plausible from the perspective of a Keynesian feedback channel theory), cyclical
loss of stability when these assumptions are violated (if speeds of adjustment become
sufficiently high), and even explosive fluctuations in the case of further increases of the
crucial speeds of adjustment of the model. In the latter case extrinsic nonlinearities have
to be introduced in order to tame the explosive dynamics as in some of the examples
in Chiarella and Flaschel (2000, Ch.6,7) where a kinked Phillips curve is employed to
achieve global boundedness.
The stability features of this - in our view properly reformulated - Keynesian dynamics
are based on specific interactions of traditional Keynes- and Mundell-effects or real rate
of interest effects (here present only in the employed investment function) with so-called
Rose or real-wage effects, see Chiarella and Flaschel (2000) for their introduction, which
in the present framework simply means that increasing wage flexibility is stabilizing
and increasing price flexibility destabilizing, based on the fact that aggregate demand
here depends negatively on the real wage (due to the assumed investment function) and
due to the extended types of Phillips curves we have employed in our new approach
to traditional Keynesian growth dynamics. The interaction of these three effects is
what explains the obtained stability results under the in this case not very important
assumption of myopic perfect foresight, on wage as well as price inflation, and thus gives
rise to a traditional type of Keynesian business cycle theory, not at all plagued by the
anomalies of the textbook AS-AD dynamics, see Chiarella, Flaschel and Franke (2004)
for a detailed treatment and critique of this textbook approach.
The model of this paper will be numerically explored in a companion paper, Asada,
Chiarella, Flaschel and Hung (2004), in order to analyze in greater depth, and also with
the empirical background here generated, the interaction of the various feedback channels
present in the considered dynamics. At that point we will make use of LM curves as
well as Taylor interest rate policy rules, kinked Phillips curves and Blanchard / Katz
error correction mechanisms in order to investigate in detail the various ways by which
a locally unstable dynamics can be made bounded and thus viable. The question then is
which behavioral assumption on private behavior and fiscal and monetary policy - once
viability is achieved - can reduce the volatility of the resulting persistent fluctuations.
Our work on related models suggests that the interest rate policy rule may not be
sufficient to tame the explosive dynamics in all conceivable cases, or even make it con-
vergent. But when viability is achieved - for example by downward wage rigidity -
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