Wage inflation

In this chapter, we will continue to develop the Keynesian model removing the assumption of fixed nominal wages. We define wage inflation πw as the percentage average increase in wages. Wages and wage inflation are still exogenous, i.e. they are not determined within the model. One justification for this assumption is that wages often are determined by agreements which often last for several years.

The main difference between the cross model and the Investment Saving, Liquidity preference Money supply (IS-LM)  model is that the nominal interest rate is exogenous in the cross model but endogenous in the IS-LM model. In this chapter we will explain how the nominal interest rate is determined in the IS-LM. P remains exogenous and constant in the IS-LM model.

The classical model” was a term coined by Keynes in the 1930s to represent basically all the ideas of economics as they apply to the macro economy starting with Adam Smith in the 1700s all the way up to the writings of Arthur Pigou in the 1930s. In this chapter I will describe the main characteristics of what we now call the classical model and how the macroeconomic variables are determined in this model. As discussed in the previous section, we focus on the cycles and all the components included in the GDP (consumption, investment, importsand exports) are variables where the trend has been removed.

The purpose of this chapter is to try to explain growth in GDP . The models in this chapter are very different from the rest of the models in this book as they use only the production function and factors of production to explain growth.

We have now reached the second part of this book. The first Interest rate was a description of the macroeconomic variables and institutions. In the second part, we will analyze how these variables fit together and present models that explain the main macroeconomic variables.

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