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Disequilibrium, Growth and Labor Market Dynamics Springer-Verlag Berlin Heidelberg GmbH Carl Chiarella· Peter Flaschel Gangolf Groh · Willi Semmler with contributions by Carsten Koper Disequilibrium, Growth and Labor Market Dynamics Macro Perspectives With 73 Figures and 23 Tables , Springer Prof.Dr. CarlChiarella Prof. Dr. Willi Semmler UniversityofTechnology, Sydney UniversityofBielefeld School ofFinance and Economics FacultyofEconomics ao.Box 123 Postfach 100131 Broadway,NSW 2007 33501 Bielefeld Sydney Germany Australia New School University [email protected] DepartmentofEconomics 65 Fifth Ave,New York Prof. Dr. PeterFlaschel NY 10003 UniversityofBielefeld USA FacultyofEconomics Postfach 100131 33501 Bielefeld Germany [email protected] Dr. GangolfGroh UniversityofMagdeburg FacultyofEconomics Postfach4120 39016 Magdeburg Germany ISBN 978-3-642-08443-0 ISBN 978-3-662-04070-6 (eBook) DOI 10.1007/978-3-662-04070-6 LibraryofCongressCataloging-in-Publication Data DieDeutscheBibliothek- CIP-Einheitsaufnahme Disequilibrium,growthandlabormarketdynamics:macroperspectivesI CarlChiarella; PeterPlaschel;GangolfGroh;WilliSemmler.- Berlin;Heidelberg;NewYork; Barcelona; HongKong;London;Milan;Paris;Singapore;Tokyo:Springer,2000 This work issubjectto copyright.Allrights arereserved,whether thewholeor part of the material is concerned, specificallythe rights oftranslation, reprinting, reuse ofil lustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storagein databanks.Duplicationofthis publication or parts thereof ispermitted only under the provisions of the German Copyright LawofSeptember 9, 1965,in its currentversion,and permission forusemustalwaysbeobtained fromSpringer-Verlag. Violationsareliableforprosecution under theGermanCopyrightLaw. © Springer-VerlagBerlin Heidelberg2000 OriginallypublishedbySpringer-VerlagBerlin Heidelbergin2000. Softcoverreprintofthehardcover Istedition2000 The useofgeneral descriptivenames, registered names,trademarks,etc.in this publi cationdoes not imply,eveninthe absenceofaspecificstatement, that such names are exempt fromthe relevant protectivelawsand regulations and thereforefreeforgeneral use. Hardcover-Design:ErichKirchner,Heidelberg SPIN10691081 42/2202-5 4 3 2 1 0- Printedonacid-freepaper Preface In this book on disequilibrium, growth and labor market dynamics we take predominantly a macroeconomic perspective. We present a working model that can easily be varied in different directions in order to subsume innovations in the literature on macroeconomics, old and new, and to contribute to important currently discussed macroeconomic issues. Our working model is set up in a way that there is a close relationship between our presented dynamic models and modern macro econometric models with disequilibrium both in the labor and the goods markets. One of our objectives is, therefore, to narrow the gap between theoretical and applied structural macrodynamic model building. We hope that the book will be a useful reference for all researchers, academic teachers and practitioners of macroeconomic and macro econometric model building who are interested in economic dynamics, independently of whether they use equilibrium or disequilibrium methods in their own research. We base this hope on the fact that our approach contains a number of unique features. The emphasis on the identification and analysis of the basic feedback mechanisms at work in modern macro economies. A detailed study of the partial as well as integrated dynamic interaction between these feedback mechanisms that consti tute the interdependence of markets and sectors of the modern macro economy. The rela tionship between the macroeconomic framework of our working model and the Walrasian, Non-Walrasian and New-Keynesian reformulations of macroeconomics. The development of a framework for the analysis of the dynamic structure of modern macro econometric models. Finally the development of an approach to the theoretical investigations of large scale macrodynamic models that involves an appropriate blend of a range of analytical, diagrammatic and numerical tools and concepts. In our view, the primary objective of macroeconomics is to analyze the aforementioned basic feedback mechanisms and other types of economic interdependence, be it on the basis of the microfounded approaches currently prevailing (which however often severely restrict the range of interacting compo nents) or on the basis of aggregates that are coherently formulated with respect to stock and flow conditions. Various material of this book has been presented at different national and international con ferences and workshops, in particular at meetings of the European Economic Association and European Econometric Society, the Annual Conferences of the Society for Computa tional Economics, the Annual Conference of Economists, Australia, the Annual Symposia of the Society for Nonlinear Dynamics and Econometrics, New York, the Conference of the So ciety of Economic Dynamics, the International Atlantic Economic Conference, the Annual Meetings of the 'Verein fiir Socialpolitik', the Workshops on Economics with Heterogeneous Interacting Agents, Italy, the Viennese Workshop on Optimal Control, Dynamic Games, Nonlinear Dynamics and Adaptive Systems, the Workshop of the International School of vi Economic Research, Siena, the Conference on 'Bifurcations and Chaos in Economic and Social Systems' in Umea / Sweden, the workshop on Econometric Model Building, New York, and the Conference on Commerce, Complexity and Evolution at the University of New South Wales/ Sydney. Parts of the book have also been presented in particular at seminars at the University of Technology, Sydney, Monash University / Melbourne, the Re serve Bank of Australia, Sydney, the Free University of Berlin, the Universities of Konstanz, Bamberg, Mainz, and Bielefeld. We want to thank the audiences of the above conferences, workshops and seminars and other scholars, colleagues and friends who have commented on our work at those various occasions. Thanks go in particular to Richard Day, Reiner Franke, Alfred Greiner, Cars Hommes, Klaus Jaeger, Stefan Mittnik, Reinhard Neck, Matthias Raith, Carsten Koper, Ingrid Kubin, Thomas Lux, Alan Powell, Hans Jiirgen Ramser, James Ramsey, Michael Woodford, and Peiyuan Zhu. October 1999 Carl Chiarella University of Technology, Sydney, Australia Peter Flaschel University of Bielefeld, Bielefeld, Germany Gangolf Groh Otto-Von-Guericke University, Madgeburg, Germany Willi Semmler University of Bielefeld, Bielefeld, Germany and New School University, New York, U.S.A Contents 1 Introduction: Integrated Macrodynamics 1 I An Overview on Foundations and Perspectives 2 Disequilibrium, Growth and Labor Market Dynamics: Foundations 13 2.1 Introduction......................... 13 2.2 Effective demand, employment and nominal adjustments 13 2.2.1 Textbook IS-LM-PC modeling. . . . . . 14 2.2.2 Keynesian IS-LM-PC analysis . . . . . . 15 2.2.3 Reinterpreting the IS-LM-PC dynamics. 18 2.3 Goods market disequilibrium and quantity adjustments 23 2.3.1 An early modeling of the trade cycle 25 2.3.2 Metzlerian inventory dynamics. 33 2.4 Labor market and real wage dynamics 41 2.4.1 The Goodwin growth cycle model. 41 2.4.2 Debt deflation and adverse real wage adjustment 48 2.5 Labor market, two Phillips-curves and nominal adjustments 52 3 Disequilibrium, Growth and Labor Market Dynamics: Synthesis and Per- spectives 61 3.1 Introduction.................... 61 3.2 The working KMG model of fluctuating growth 62 3.3 Integrated macrodynamics in an open economy 75 3.4 Microfoundations and macromechanisms 86 3.5 Macroeconometric model building . . . . 96 3.5.1 The national accounts of the model 97 3.5.2 The implied CTD growth model. 101 3.5.3 The 18D core dynamics ..... 103 viii 3.5.4 Numerical investigations 106 3.6 Summary and outlook 111 3.7 Appendices .. . 113 3.7.1 Notation. 113 3.7.2 The working model in extensive form .. 114 II The Working Model: Walrasian, Non-Walrasian and New Keynesian Reformulations 4 Flex-Price Approaches: Exceptional Limit Cases? 123 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . 123 4.2 Sluggish adjustments: An extended KMG reference case 124 4.3 Substitution and endogenous technical change ...... 134 4.4 Market clearing: Classical real and dichotomizing nominal dynamics? 143 4.5 Market clearing: Walrasian reformulation and saddle point stability 153 4.6 KMG equilibrium growth. 168 4.7 Summary ......... 178 4.8 Appendix: Labor market dynamics and classical viability . 180 5 Fix-Price Approaches: Regime Switching Overstated 189 5.1 Introduction . . . . . . . . . . . . . . . . . . 189 5.2 A Non-Walrasian model of monetary growth 191 5.3 From No n-Walrasian to Keynesian modeling of monetary growth . 196 5.4 Regime switching in KMG growth .......... 201 5.4.1 Supply bottlenecks with positive inventories 201 5.4.2 Exhausted inventories and excessive aggregate demand 212 5.4.3 Numerical analysis 216 5.5 Summary ......... 222 5.6 Solow and Stiglitz (1968): An early Non-Walrasian contribution 223 6 Market Imperfections: Basic Integration and Comparison 229 6.1 Introduction . . . . . . . . . . . . . . 229 6.2 A discrete-time KMG reference case. 232 6.3 Imperfect competition: Given income distribution 247 6.3.1 Revising the wage-price module of KMG growth. 250 6.3.2 The 2D stagflation subdynamics: Local analysis . 255 ix 6.3.3 Global characteristics of the 2D case 258 6.3.4 Kinked Phillips curves: 2D analysis . 260 6.3.5 4D and 6D extensions of the 2D stagflation dynamics 265 6.4 Imperfect competition: Adjusting income distribution . 271 6.4.1 Marked up marginal wage costs 272 6.4.2 Profit share targets . 277 6.4.3 Markup adjustments 281 6.5 Summary ....... . . . 283 III The Perspective: Theoretical Aspects of Modern Macro econometric Model Building 7 Applied Disequilibrium Growth Theory 289 7.1 Introduction ............... . 289 7.2 A general framework for modeling disequilibrium growth 293 7.2.1 The assumed structure of the economy ..... . 293 7.2.2 The structure from the viewpoint of national accounting 297 7.2.3 Aggregate concepts from the system of national accounts 303 7.3 Households 305 7.4 Firms ... 317 7.5 Government and the monetary authority 323 7.6 Quantity and price adjustment. 325 7.7 Asset market dynamics. 330 7.8 The foreign sector ... . 332 7.9 A summing up .... . 334 7.10 Macroeconometric model building of the AS-AD type: A brief comparison 338 7.11 Appendix A: Notation . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 346 7.12 Appendix B: Representing technology by nested CES / CET production functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 349 8 Intensive Forms and Steady State Calculations 353 8.1 Introduction..................... 353 8.2 The real and the financial structure of the economy 356 8.2.1 The real sector ... 356 8.2.2 The financial sector 358 8.2.3 National accounting 359

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