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

Abstract

In this paper, we reformulate the theoretical baseline DAS-AD model of Asada, Chen, Chiarella and Flaschel (2004) to allow for its somewhat simplified empirical estimation. The model now exhibits a Taylor interest rate rule in the place of an LM curve and 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 6D model of real markets disequilibrium dynamics avoids striking anomalies of the old Neoclassical synthesis and can be usefully compared with the model of the new Neoclassical Synthesis when the latter is based on both staggered prices and wages. It exhibits typical 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 provide system estimates of the equations of the model in order to study its stability features based on empirical parameter estimates with respect to its various feedback channels. Based on these estimates we find that the dynamics is strongly convergent around the steady state, but will loose this feature if the inflationary climate variable adjusts sufficiently fast. We also study to which extent more active interest rate feedback rules or downward wage rigidity can stabilize the dynamics in the large when the steady state is made locally repelling by a faster adjustment of inflationary expectations. We find support for the orthodox view that (somewhat restricted) money wage flexibility is the most important stabilizer in this framework, while monetary policy should allow for sufficient steady state inflation in order to avoid stability problems in areas of the phase space where wages are still not very flexible in a downward directionDAS-DAD growth, wage and price Phillips curves, nonlinear estimation, stability, economic breakdown, persistent cycles, monetary policy.