Macroeconomic Stability or Cycles? The Role of the Wage-Price Spiral
Dag Kolsrud and Ragnar Nymoen
Published in Australian Economic Papers, Vol. 53, Issue 1-2, June 2014, pp 41 - 68
We formulate a small and stylised dynamic macroeconomic model, and study how different specifications of the supply side affect the model's dynamic properties. The wage-price equilibrium-correction model (ECM) and the Phillips curve model (PCM) that both can be used to represent the supply side of a New Keynesian macro model, are synthesised in a generalised model of the wage-price spiral. We show that the choice of ECM or PCM has implications for the long-run stability of the macro model, without need of a NAIRU. We also find that the range of theoretically admissible dynamics is wide. For example, both the ECM and PCM may display endogenous cyclical fluctuations in inflation and unemployment, showing that even simple structures can give rise to complex dynamics. In practice that may entail that forecasting the effects of shocks and policy changes is difficult even in the best of circumstances.