Chaos in the "Forward-looking Expectations-augmented Phillips Curve" with "Price Catch-up"

Chaos in the "Forward-looking Expectations-augmented Phillips Curve" with "Price Catch-up" (di Luciano Fanti) - ABSTRACT: In this paper we investigated the dynamical properties of a text-book "expectations-augmented Phillips curve" model with the forward-looking behaviour argued by Phelps and Friedman, extended with a pro-cyclical mark-up. The main results are that far-sighted forward-looking agents can destabilise the neoclassical labour market and that "saddle-path stability" can never occur; this can be considered another example of "indeterminacy" of the Walrasian equilibrium. Moreover, including compensation for past unexpected inflation, persistent oscillations and chaotic behaviour (very robust as well as very realistic) appear, interestingly when agents tend towards perfect foresight. When convergence to the Walrasian equilibrium fails, the emergence of a chaotic attractor produces a ‘Phillips curve’ - type behaviour as a true long-run phenomenon. Therefore on the one hand we showed that the Phelps-Friedman’s view of the Phillips curve with an endogenous price inflation section, may generate an ‘indeterminate’ as well as unstable labour market equilibrium. However, on the other hand, the criticism levelled by Phelps-Friedman at the use of the Phillips curve as a policy tool is confirmed here to the extent that the long-run Phillips curve is only the result of the existence of a chaotic attractor.

Luciano Fanti, Chaos in the "Forward-looking Expectations-augmented Phillips Curve" with "Price Catch-up" in "STUDI ECONOMICI " 77/2002, pp , DOI: