Abstract
In this chapter we start the investigation of a model type that not only allows for sluggish wage, but also for sluggish price and quantity adjustments, implying in particular over- or underutilized labor as well as capital in the evolution of the economy and a resulting real wage dynamics that allows for a variety of stability scenarios with respect to the role of income distribution.1 We thus depart significantly from the conventional IS-LM-PC analysis of the part I of the book which there provided the basis for an elaborate Dornbusch type open economy macrodynamics. We will integrate this exchange rate dynamics later on into the now considered type of macrodynamics, in chapters 8 – 10 of the book, after an application of the closed economy model of this chapter to a large open economy within a fixed exchange rate area, in chapter 7, where the focus is still on trade in commodities and not yet on trade in financial assets. As an example for the closed economy macrodynamics that follows we consider, as the title of this chapter indicates, the US-economy in the period following World War II. The here presented model of a closed economy has indeed successfully been applied to and estimated for the US-economy for U.S. time series data 1960.1–1995.1 in Flaschel, Gong and Semmler (2001), see section 3 below for a brief summary of their results. This model may therefore be considered a valid first approximation in an attempt to model the US-economy on the basis of sluggish wage, price and quantity adjustments and fluctuating rates of capacity utilization for both labor and capital, see also Obstfeld and Rogoff (2001, p.172) who state there ‘that the US-economy still remains a surprisingly closed economy’.2
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This chapter builds on and elaborates work done jointly with Gang Gong and Willi Semmler, see Chiarella, Flaschel, Gong and Semmler (2003), by proving in detail theorem 6.2 that was only sketched in their paper and by adding to it some further numerical investigations. Furthermore, in an appendix, we now also provide the complete presentation of the model on its extensive form level. In the discussion of the dynamics of the model we however follow this paper of Chiarella et al. in its intuitive presentation of the main building blocks and the central implications of this type of Keynesian macrodynamics.
See also Obstfeld and Rogoff (2000) and here chapter 7 for a model of a large open economy in a fixed exchange rate area that is still closely related to the closed economy case we consider in the present chapter.
The detailed consideration of interest rate policy rules is definitely a significant step forward, particularly pushed ahead within the context of the New IS-LM model of New Keynesian theory. Up to the present chapter and the next one we will however not go into the contemporaneous discussion of such monetary policy rules, see however King (2000) and Spahn (2001b) and their references for example, but will postpone this discussion to a later publication here (Chiarella, Flaschel, Franke and Skott, 2003 ).
See Keynes (1936), Metzler (1941) and Goodwin (1967) for the approaches this model type is referring to in its denomination, which may here be briefly characterized as the interaction of Keynes’ marginal propensities to consume, marginal efficiencies to invest, liquidity preferences, Metzlerian inventory-output adjustment mechanisms and finally a Goodwinian approach to the role played by income distribution. As indicated above the list of potential contributors to the framework here adopted may however be considered to be a much longer one.
The use of two in the place of only one Phillips curve - an unquestioned procedure during the rise of structural macroeconometric model building, see Chiarella, Flaschel, Groh and Semmler (2000) for a discussion of this on various levels of generality - is gathering force again, as indicated for example by the topics investigated in Cohen and Fahri (2001) and Mehra (2000). There are indeed numerous such questions to be obtained from a closer look at the wage-price spiral in the place of the single reduced form Phillips curve of mainstream Keynesian theory, whether old or new.
This is in line with estimates of the wage equation in the macroeconometric model of, for example, the German Bundesbank, see the az estimates in Deutsche Bundesbank (2000, p.52).
The New Keynesian approach to the business cycle theory and in particular monetary policy is considered and evaluated in detail in King (2000). We do not go into such a discussion — on the New IS-LM model — in the present book which in this chapter in our view provides a significant alternative to the New Keynesian approach for the closed economy. A comparison with the New Keynesian IS-LM theory with its stress on microfounded, intertemporal and forward-looking behavior will be provided in Chiarella, Flaschel, Franke and Skott (2003) where the potentials and limitations of both approaches will be discussed and evaluated.
These quantity dynamics have been studied in isolation, with a nonlinearity in the inventory adjustment process, in Franke and Lux (1993) and with capital stock growth in Franke (1996).
We note in passing that our dynamic-AS dynamic-AD model is at least in one respect still unbalanced, since we make use of a mixture of short-and medium-run expressions in the risk premium term in the investment function. Correcting this basically would introduce a further law of motion — for the investment climate — into the dynamics considered below without too much change in the model’s implications; see Asada and Flaschel (2003) in this regard.
See Chiarella and Flaschel (2000a) for the details of this Keynesian working model, including the specification of all budget and behavioral equations on the extensive form level, and Chiarella, Flaschel, Groh and Semmler (2000) for various extensions of this model type.
Cf. Chiarella and Flaschel (2000a, ch.6) and see also Köper (2000) for the first detailed presentations of such a stability investigation by means of varying adjustment speeds ß 3 where j = n, re, w.
The discrete time version of the considered dynamics is presented in full detail in Flaschel, Gong and Semmler (2001) on the extensive as well as on the intensive form level.
Such a finding also holds for the Bergstrom model of the UK economy; see Barnett and He (1998, 1999a,b) for numerical studies of this macroeconometric model.
The fact that a more active monetary policy can be destabilizing is also shown in Benhabib et al. (2001), there however in an optimizing macro-model.
See Köper (2000) for an alternative presentation of this KMG model with Kaldorian saving habits and Harrod-neutral technical change and Chiarella, Flaschel, Groh and Semmler (2000) for various extensions of this model type.
See Chiarella, Flaschel, Groh and Semmler (2000, part III) for the treatment of much more general situations.
See again Chiarella, Flaschel, Groh and Sommier (2000, part III) for the treatment of much more general situations.
Chiarella and Flaschel (2000a, ch.5) show that such an approach can be extended to the case of smooth factor substitution without much change to the qualitative behavior of the model.
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Asada, T., Chiarella, C., Flaschel, P., Franke, R. (2003). KMG Model Building: The Baseline Case of a ‘Closed’ US-Economy. In: Open Economy Macrodynamics. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-540-24793-7_6
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DOI: https://doi.org/10.1007/978-3-540-24793-7_6
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