Finance Discipline Group
UTS Business School
University of Technology, Sydney

Working Paper Series

Keynesian Disequilibrium Dynamics: Convergence, Roads to Instability and the Emergence of Complex Business Fluctuations
Author(s): Pu Chen, Carl Chiarella, Peter Flaschel & Hing Hung
Date of publication: March 2006
Working paper number: 146
We reformulate the traditional AS-AD growth model of the Neoclassical Synthesis (stage I) with a Taylor policy rule replacing the conventional LM-curve, with gradually adjusting wages as well as prices, and with perfect foresight on current inflation rates and an adaptively revised notion of an inflationary climate in which the economy is operating. We compare this approach with the New Keynesian approach, the Neoclassical Synthesis, stage II, with staggered price and wage setting and find various common components, yet with radically different dynamic implications due to our treatment of the forward-looking part of our wage-price spiral. We show for a system estimate of our model that it implies qualitatively local asymptotic stability and when its estimated form is simulated in response to isolated shocks strongly damped business fluctuations, due to a stable interaction of goods market dynamics with the interest rate policy of the central bank and due to a normal working of a real-wage feedback chain. These results are however endangered – leading in fact to economic breakdown – when there is a global floor to money wage inflation rates. In this case, the return of some money wage flexibility in deep depressions is of help in restoring viability of the model, thereby even avoiding explosive dynamics and the collapse of the economy. This situation leads to viable, but complex business fluctuations.
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Known citations:

Asada, T., Chen, P. Chiarella, C. and Flaschel, P., 2006, "Keynesian Dynamics and the Wage-Price Spiral: A Baseline Disequilibrium Model", Journal of Macroeconomics, 28(1), 90-130.

Chen, P., Chiarella, C., Flaschel, P. and Semmler, W., 2006, "Keynesian Macrodynamics and the Phillips Curve. An Estimated Baseline Macromodel for the U.S. Economy", Working Paper Number: 147, Finance Discipline Group, University of Technology, Sydney.

Ernst, E., Flaschel, P., Proano, C. and Semmler, W., 2006. "Disequilibrium Macroeconomic Dynamics, Income Distribution and Wage-Price Phillips Curves", IMK Working Paper 04-2006, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.

Hayo, B. and Niehof, B., 2013, "Spillovers in a New Keynesian Continuous Time Framework with Financial Markets", Working Paper.