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Keynesian AD-AS, Quo Vadis?

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Abstract

We formulate a dynamic AD-AS model based on gradually adjusting wages and prices, perfect foresight of current inflation rates and adaptive expectations concerning the inflation climate in which the economy operates. The model consists of a wage and a price Phillips curve, a dynamic IS curve as well as a dynamic employment adjustment equation (Okun’s law) and a Taylor interest rate rule. The model can be reduced to a 3D dynamical system by a suitable choice of the Taylor rule and implies strong stability results, in particular for an appropriately chosen interest rate policy rule. Through instrumental variables GMM system estimation with aggregate time series data for the U.K. economy, we obtain parameter estimates which support the specification of our theoretical model and its stability implications. We contrast these results with the standard (formally similarly structured) New Keynesian model with staggered wage and price setting where determinacy of the dynamics represents a severe problem and where (if determinacy can be achieved) inertia-free stability is obtained by the very choice of the solution method.

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  • Toichiro Asada & Carl Chiarella & Peter Flaschel & Christian R. Proaño, 2007. "Keynesian AD-AS, Quo Vadis?," Working Paper Series 151, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  • Handle: RePEc:uts:wpaper:151
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    File URL: http://www.finance.uts.edu.au/research/wpapers/wp151.pdf
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    1. Blanchard, Olivier J, 1981. "Output, the Stock Market, and Interest Rates," American Economic Review, American Economic Association, vol. 71(1), pages 132-143, March.
    2. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    3. Gali, Jordi & Gertler, Mark & Lopez-Salido, J. David, 2001. "European inflation dynamics," European Economic Review, Elsevier, vol. 45(7), pages 1237-1270.
    4. Krolzig, Hans-Martin & Peter Flaschel, 2003. "Wage and Price Phillips Curves," Royal Economic Society Annual Conference 2003 128, Royal Economic Society.
    5. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
    6. Chiarella, Carl & Flaschel, Peter, 1996. "Real and monetary cycles in models of Keynes-Wicksell type," Journal of Economic Behavior & Organization, Elsevier, vol. 30(3), pages 327-351, September.
    7. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
    8. Chen Pu & Flaschel Peter, 2006. "Measuring the Interaction of Wage and Price Phillips Curves for the U.S. Economy," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 10(4), pages 1-35, December.
    9. Robert J. Barro, 1994. "The Aggregate-Supply/Aggregate-Demand Model," Eastern Economic Journal, Eastern Economic Association, vol. 20(1), pages 1-6, Winter.
    10. Lawrence F. Katz & Olivier Blanchard, 1999. "Wage Dynamics: Reconciling Theory and Evidence," American Economic Review, American Economic Association, vol. 89(2), pages 69-74, May.
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    12. Jordi Galí, 2000. "The return of the Phillips curve and other recent developments in business cycle theory," Spanish Economic Review, Springer;Spanish Economic Association, vol. 2(1), pages 1-10.
    13. Pu Chen & Carl Chiarella & Peter Flaschel & Willi Semmler, 2006. "Keynesian Macrodynamics and the Phillips Curve. An Estimated Baseline Macromodel for the U.S. Economy," Working Paper Series 147, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
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    Keywords

    AS-AD; wage and price Phillips curve; real wage dynamics; stability; monetary policy;

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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