Summary and implications
of sect 8.1 and 8.2 in “Dynamic models”.
Two dynamic models of wages which are both consistent with the long run
propositions of the main-course theory.
1. First model (in sec 8.1): ADL model for wage level: DL part made up of
main-course variable (mct) and the rate of unemployment (ut).
(a) If we assume a stable solution of the ADL (i.e., 0 < α < 1), it can be
transformed to an ECM for wage growth.
(b) For a given (exogenously determined) level of ut, wage growth errorcorrects deviations form the main-course.
(c) Therefore, there is a steady state level for the ware share wt − mct.
2. Second model (in sec 8.2): If there is no stable solution of the ADL
(i.e.,α = 1), there is no valid ECM for wages either. Instead, a Phillips
curve model (PCM) for wage growth applies.
(a) The PCM gives an unstable solution for the wage-share wt − mct.
(b) If the PCM is linked up with a second equation, which explains ut as an
increasing function of the wage share, the two equation system implies
a steady state level for the ware share wt − mct.
(c) The PCM implies a natural rate of unemployment (uphil ) which correspond steady state level of unemployment implied by the 2-equation
system.
(d) Stability of wage growth and inflation also follows.
38a
38b
3. Hence both models (ECM and PCM) stabilizes the wage share, and the
rates of wage and price inflation.
5. Important implications for policy: For example:
4. The difference between the models lies in the mechanism that secures
stability of the wage share
(a) If PCM is the true model, then self-defeating policy to try to target
“full employment”
below the natural rate.
(a) In the ECM case: Collective rationality in wage setting institutions.
For example: Unions adjust their wage claims to the last years profitability. Wage (and price) inflation is stabilized at any given rate of
unemployment (also low ones!)
(b) If ECM is the true model then it is not only possible to target full
employment, it may also be advisable in order to maintain collective
rationality (avoid breakdown in the bargaining system/institutions)
(b) In the PCM case: Little collective rationality. Instead unemployment
serves as a diciplining device: There is only one level of unemployment
at which the rate of inflation is stable.
38d