Underemployment with flexible prices in a simplified model of Keynes’s "shifting equilibrium" - Developments on the "static model of a dynamic process"

Competitive equilibrium in the General Theory is defined as "shifting" in the sense that, due to fundamental uncertainty, individuals' decisions at any point in time depend on their subjective views of the future, so that equilibrium has no "natural" position, anchored in reliable knowledge of future consequences. This is also what makes it intrinsically dynamic, since the system evolves in function of the change in subjective views induced by its own evolution. In her Macroeconomics After Keynes, Victoria Chick (1983) pointed out that the method of the General Theory consists in treating the views about the future as given at a point in time, which makes it possible to study the equilibrium resulting from individual decisions using a static model of the shifting equilibrium. The paper proposes a linear modelling of shifting equilibrium closely based on the General Theory. One of its main features is that it allows for endogenous determination of all key variables, including the equilibrium wage, generally taken as given because of the well-known depressive – and therefore destabilising – effects caused by a fall in wages in a system with underemployment. Equilibrium is nevertheless preserved due to the forces involved in "endogenous institutional stabilisers". Although, from a strictly formal point of view, the equations of the model bear similarities with IS-LM - AS-AD type constructions, it provides radically different insights depending on the theoretical framework used to examine its properties.