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



adjustment of the inflationary climate) where the need for further (behavioral) nonlin-
earities therefore becomes established, to be investigated and discussed in a companion
paper to the present one (Asada, Chiarella, Flaschel and Hung, 2004).

Section 2 presents our reformulation of the baseline Keynesian DAS-AD growth dynamics
of Asada, Chen, Chiarella and Flaschel (2004) as a DAS-DAD growth dynamics in order
to make this model applicable to empirical estimation. Section 3 considers the feedback
chains of the reformulated model and derives cases of local asymptotic stability and
of loss of stability by way of Hopf-bifurcations. In section 4 we estimate the model
to find out sign restrictions and which type of feedback mechanisms may apply to the
US-economy after World War II. Section 5 then investigates again the stability of the
dynamics on the basis of these sign restrictions and determines stability boundaries with
respect to the adjustment speed of prices and the inflationary climate variable. Section 6
concludes and considers briefly behavioral assumptions that may provide global stability
to the economy in the cases where the steady state is surrounded by centrifugal forces.
We there also discuss in which way the resulting persistent fluctuations will be influenced
through a stronger conduct of interest rate policy rules.

2 Keynesian disequilibrium dynamics: Empirically
oriented reformulation of a baseline model

In this section we reformulate the theoretical disequilibrium model of AS-AD growth of
Asada, Chen, Chiarella and Flaschel (2004) in order to make it applicable for empirical
estimation and for the study of the role of contemporary interest rate policy rules. We
thus dismiss the LM curve of the original approach and replace it now by a Taylor
interest rate policy rule and now also use dynamic IS as well as employment equations
in the place of static ones of the original approach, where with respect to the former the
dependence of consumption and investment on income distribution now only appears
in aggregated or reduced type format. We furthermore now use Blanchard and Katz
(2000) type error correction terms both in the wage and the price Phillips curve that
give income shares a role to play in wage as well as in price dynamics. Finally, we will
add inflationary inertia to a world of myopic perfect foresight through the inclusion of
a medium-run variable, the inflationary climate in which the economy is operating, and
its role in the wage and price dynamics of the considered economy.

We start from the observation that a Keynesian model of aggregate demand fluctuations
should (independently of whether justification can be found for this in Keynes’ General
Theory) allow for under- (or over-)utilized labor
as well as capital in order to be general
enough from the descriptive point of view. As Barro (1994) for example observes, IS-
LM is (or should be) based on imperfectly flexible wages
and prices and thus on the
consideration of wage as well as price Phillips Curves. This is precisely what we will do
in the following, augmented by the observation that medium-run aspects count both in
wage and price adjustments, here still formulated in simple terms by the introduction
of the concept of an inflation climate. This economic climate term is based on past
observation, while we have model-consistent expectations with respect to short-run wage



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