Keynesian Dynamics and the Wage Price Spiral. A Baseline Disequilibrium Approach

We reformulate and extend the standard AS-AD growth model of the Neoclassical Synthesis (Stage I) with its traditional microfoundations. The model still has an LM curve in the place of a Taylor interest rate rule, exhibits sticky wages as well as sticky prices, myopic perfect foresight of current inflation rates and adaptively formed medium run expectations concerning the investment and inflation climate in which the economy is operating. The resulting nonlinear 5D model of labor and goods market disequilibrium dynamics avoids striking anomalies of the standard model of the Neoclassical synthesis (Stage I). It exhibits instead Keynesian feedback dynamics proper with in particular asymptotic stability of its unique interior steady state for low adjustment speeds and with cyclical loss of stability – by way of Hopf bifurcations – when some adjustment speeds are made suficiently large, even leading to purely explosive dynamics sooner or later. In such cases downward money wage rigidity can be used to make the dynamics bounded and thus viable. In this way we obtain and analyze a baseline DAS-AD model with Keynesian feedback channels whose rich set of stability features is the source of business cycle fluctuations. These outcomes of the model stand in contrast to those of the currently fashionable New Keynesian alternative (the Neoclassical Synthesis, Stage II) that we suggest is more limited in scope.