Heuristic vs formal dynamics of the wage- and price-curve model of equilibrium unemployment

Dag Olaf Kolsrud and Ragnar Nymoen

Journal of Economic Studies

Photo: Emerald

Published in:

Journal of Economic Studies 2015 42 (2) pp.186-206

DOI: 10.1108/JES-05-2013-0074

Abstract:

Purpose – A standard model of equilibrium unemployment consists of static equations for real-wage ambitions (wage curve) and real-wage scope (price curve), which jointly determine the NAIRU. The heuristics of the model states that unless the rate of unemployment approaches the NAIRU from any given initial value, inflation will be increasing or decreasing over time. The paper aims to discuss these issues.

Design/methodology/approach – The authors formalize this influential heuristic argument with the aid of a dynamic model of the wage-price spiral where the static theory’s equations are re-interpreted as attractor relationships.

Findings – The authors show that NAIRU unemployment dynamics are sufficient but not necessary for inflation stabilization, and that the dynamic wage-price spiral model generally has a dynamically stable solution for any predetermined rate of unemployment. The authors also discuss a restricted version of the model that conforms to the accelerationist view that inflation increases/falls if unemployment is not at its “natural rate”.

Research limitations/implications – To investigate the relevance of heuristical dynamics of influential macro models, explicit modelling of such dynamics is a necessary step.

Practical implications – An important argument against social orders that represent an attempt to target unemployment at relatively low levels, is refuted by the analysis.

Social implications – A high degree of employment is a main premise for a social order with equal income distribution and a drive for productivity growth.

Originality/value – It is important that economics give a balanced view of the possibility of attaining inflation stability at low or moderate levels of unemployment. This offering is contributions to establish such a balance.

Published Sep. 23, 2015 3:09 PM - Last modified Dec. 16, 2015 2:52 PM