Keynesian AD-AS Vadis?

University of Sydney School of Finance and Economics Working Paper No. 151

44 Pages Posted: 17 Mar 2008

See all articles by Toichiro Asada

Toichiro Asada

Chuo University

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group

Peter Flaschel

Bielefeld University - Department of Business Administration and Economics

Christian Proaño

affiliation not provided to SSRN

Date Written: November 2007

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.

Keywords: AS-AD, wage and price Phillips curve, real wage dynamics, stability, monetary policy

JEL Classification: E24, E31, E32

Suggested Citation

Asada, Toichiro and Chiarella, Carl and Flaschel, Peter and Proaño, Christian, Keynesian AD-AS Vadis? (November 2007). University of Sydney School of Finance and Economics Working Paper No. 151, Available at SSRN: https://ssrn.com/abstract=1106073 or http://dx.doi.org/10.2139/ssrn.1106073

Toichiro Asada

Chuo University ( email )

2nd floor Blg 4 Tampa Campus
742-1 Higashinakano, Hachioji
Tokyo 192-03
Japan

Carl Chiarella (Contact Author)

University of Technology, Sydney - UTS Business School, Finance Discipline Group ( email )

PO Box 123
Broadway, NSW 2007
Australia
+61 2 9514 7719 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://www.business.uts.edu.au/finance/

Peter Flaschel

Bielefeld University - Department of Business Administration and Economics ( email )

P.O. Box 100131
D-33501 Bielefeld, NRW 33501
Germany

Christian Proaño

affiliation not provided to SSRN ( email )