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The Diamond Of Macroeconomic Equilibria And Non‐Inflationary Expansion

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  • Ian M. McDonald
  • Hugh Sibly

Abstract

This paper combines the microeconomic foundations of earlier models of a range of equilibrium rates of employment to generate a model with a diamond of equilibria. Analysis of the diamond model shows that for a depressed economy an expansionary aggregate demand policy can, without violating rational expectations of inflation, generate a central proposition of Keynesian economics—a non‐inflationary expansion (NIE), that is a permanent increase in employment without increasing inflation. The microeconomic foundations of the model draw on ideas of customer markets, reference dependence and loss aversion. It is also shown that the possibility of achieving an NIE is enhanced if a macro price policy, such as incomes policy or inflation targeting, accompanies the expansion in aggregate demand.

Suggested Citation

  • Ian M. McDonald & Hugh Sibly, 2005. "The Diamond Of Macroeconomic Equilibria And Non‐Inflationary Expansion," Metroeconomica, Wiley Blackwell, vol. 56(3), pages 393-409, July.
    • Handle: RePEc:bla:metroe:v:56:y:2005:i:3:p:393-409
    DOI: 10.1111/j.1467-999X.2005.00222.x
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    References listed on IDEAS

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    1. Stiglitz, J E, 1979. "Equilibrium in Product Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 69(2), pages 339-345, May.
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    4. Daniel Kahneman & Jack L. Knetsch & Richard H. Thaler, 1991. "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter.
    5. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
    6. Amos Tversky & Daniel Kahneman, 1991. "Loss Aversion in Riskless Choice: A Reference-Dependent Model," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 106(4), pages 1039-1061.
    7. Geoffrey Woglom, 1982. "Underemployment Equilibrium with Rational Expectations," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 97(1), pages 89-107.
    8. Nicholas Rowe, 1987. "An Extreme Keynesian Macro-economic Model with Formal Micro-economic Foundations," Canadian Journal of Economics, Canadian Economics Association, vol. 20(2), pages 306-320, May.
    9. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, vol. 76(4), pages 728-741, September.
    10. Kling, Arnold, 1982. "Imperfect Information and Price Rigidity," Economic Inquiry, Western Economic Association International, vol. 20(1), pages 145-154, January.
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    Cited by:

    1. Ian McDonald, 2007. "Where Is Full Employment?," Department of Economics - Working Papers Series 1011, The University of Melbourne.
    2. Ahrens, Steffen & Pirschel, Inske & Snower, Dennis J., 2017. "A theory of price adjustment under loss aversion," Journal of Economic Behavior & Organization, Elsevier, vol. 134(C), pages 78-95.
    3. repec:hum:wpaper:sfb649dp2014-065 is not listed on IDEAS
    4. Steinar Holden & Fredrik Wulfsberg, 2007. "How strong is the case for downward real wage rigidity?," Working Papers 07-6, Federal Reserve Bank of Boston.
    5. Holden, Steinar & Wulfsberg, Fredrik, 2009. "How strong is the macroeconomic case for downward real wage rigidity?," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 605-615, May.
    6. Ian McDonald, 2009. "Behavioural macroeconomics and wage and price setting: Developing some early insights of John Maynard Keynes and Joan Robinson," CAMA Working Papers 2009-11, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.

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