Macroeconomic fluctuations in a New Keynesian disequilibrium model

Bas Van Aarle

doi:10.1186/s40008-017-0070-2

Abstract

This study extends the current New Keynesian modeling framework by changing one crucial aspect: it replaces the general equilibrium assumption by the arguably more realistic assumption of macroeconomic disequilibrium. As a result, more complex and less smooth macroeconomic adjustment dynamics result, as it is not necessary to assume that goods and labor markets continuously clear. The disequilibrium dynamics in the form of regime-dependent output-, employment-, price- and wage fluctuations complicate the decision making problems faced by the fiscal and monetary policy makers substantially. In particular, the possibility of (multiple) regime switches implies the need for deeper analysis and careful monitoring of the disequilibrium mechanisms and dynamics when designing and implementing monetary and fiscal policies.

Highlights

Some theorists seem to think that full market clearing provides an unavoidable analytical hypothesis in general theories and is a universal feature in market economies
This study extends the current New Keynesian modeling framework by changing one crucial aspect: it replaces the general equilibrium assumption by the arguably more realistic assumption of macroeconomic disequilibrium
Wage and price dynamics are regime dependent in the disequilibrium model: wages and prices adjust depending on the current regime, and over time regime switches may occur which will imply a change in the adjustment dynamics of wages and prices, due to the changes in the rationing conditions in goods and labor markets

Summary

Introduction

Some theorists seem to think that full market clearing provides an unavoidable analytical hypothesis in general theories and is a universal feature in market economies. The disequilibrium approach does not rely on the general equilibrium assumption and instead considers the possibility of significant non-market clearing—i.e., persistent divergence between supply and demand, implying rationing by the short side of the market—to explain unemployment and business cycle fluctuations.4 It defines regimes of disequilibrium and analyses disequilibria as a result of shocks, policy adjustments and wage and price adjustments.

Results

Conclusion