A dynamic general disequilibrium model of a sequential monetary production economy

Abstract

A discrete, deterministic, economic model, based on the framework of non-Walrasian or disequilibrium economics, is presented. The main feature of this approach is the presence of non-clearing markets, where not all demands and supplies are satisfied and some agents may be rationed. The model is characterized by three agents (i.e., a representative firm, a representative consumer, and a central bank), three commodities (i.e., goods, labour and money, each homogeneous) and three markets for their exchange. The imbalance between demand and supply in each market determines the dynamics of price, nominal wage and nominal interest rate. The central bank provides the money supply according to an operating target interest rate that is fixed accordingly to Taylor’s rule. The model has been studied by means of computer simulations. Results pointed out the presence of business cycles that can be controlled by proper policies of the central bank.

Introduction

Under the Walrasian approach [1], [2], agents take as given a common perception of relative prices and send quantity signals (demands and supplies) to the Walrasian auctioneer which provides to adjust the relative prices in order to equilibrate the system and sets excess demands to zero. In the Walrasian framework, realized and expected quantity signals do not affect agents behaviour. Indeed, the Walrasian framework is a good description of reality for the few real world markets, such as the stock market which inspired Walras, where the equality between demand and supply is ensured institutionally by an actual auctioneer. Conversely, some markets, e.g., the goods and labour markets, where a central auctioneer is not present, often do no clear. The failure of a market clearing implies that, for at least some agents, actual quantities transacted diverge from the quantities which they supply or demand. Thus, an agent should take also into account quantity signals issued by other agents in addition to price signals.

The disequilibrium or non-Walrasian approach to economics has been pioneered in the 1960s by Patinkin [3], Clower [4] and Leijonhufvud [5] and flourished in the 1970s especially among European economists [6], [7], [8], [9]. Within the non-Walrasian approach to economics, markets generally do not clear and agents engage in maximizing behaviour facing quantity constraints in their buying or selling decision. Furthermore, demand–supply imbalances in one market influence the disequilibrium in another market, e.g., the well-known spillover effects between goods market and labour market. Barro and Grossman [10] examined how the goods and the labour markets interact when prices are fixed at non-market clearing levels. Varian [11] showed that non-Walrasian equilibria can persist in dynamic models with flexible prices. Recently, Bénassy [12], [13] endogenized the price setting mechanism within the framework of monopolistic competition where sellers are usually price makers and quantity takers, whereas buyers are price takers and quantity setters.

This paper is intended to study the connections between real economic activity, i.e., production, employment and growth, and the dynamics of some financial variables, i.e., money supply and interest rates. A corner stone in this respect is the famous IS-LM model, derived by Hicks [14] on the basis of The General Theory of Keynes. A remarkable development of this approach is the deterministic macro-dynamic model proposed by Blanchard in 1981 [15], and recently extended by Chiarella et al. [16]. With respect to these approaches, the model presented here is characterized by a micro-foundation of demand and supply schedules, which are derived from agents optimized behaviour, and by the presence of an endogenous money supply, that depends on a target interest rate that is fixed by Taylor’s rule. In particular, this feature is able to reproduce endogenous business cycles.

The disequilibrium approach is adopted in this study. Thus, distinctive features of this model are non-clearing goods, labour and money markets, where the size of imbalance between demand and supply determines the size of adjustment of the corresponding prices (i.e., goods price, wage, and interest rate). Furthermore, the speed of adjustment for goods and labour market is far lower than that for money market, taking into account the well-known rigidity of prices of goods and salaries. The representative firm makes production and investment decisions according to a profit maximization rule which takes into account constraints in labour supply by the representative consumer and the endowment of productive capacity.

Results pointed out the main relations between economic variables. Furthermore, the proposed model is characterized by business cycles that can be governed by a proper central bank monetary policy.