I have been told that Keynesians do not believe that this is possible. Is this true? What other models accommodate stagflation? So, here is a monetarist model that admits to simultaneous inflation and recession:
Preprint Money, Inflation, and a Macro Model
Congratulations on your interesting approach to stagflation in a macro model! If one supplements a simple IS/LM model with an informal sector (shadow economy) modeled according to the Laffer curve approach and also takes into account the demand for money there (illicit cash), recessive tendencies can be derived for the formal sector in such a context, which at the same time indicate the reduction of the money supply in the official sector cause price increases. However, the stagflationary process is only one possible constellation among a total of six, but nothing can be said about their real economic relevance and frequency. See also
https://www.researchgate.net/publication/274331552_The_Laffer_Curve_and_Illicit_Cash_in_Simple_Macroeconomic_Models
Hans-Georg,
Let's see if we have something in common here. You note that there is a Laffer curve that has positively and negatively sloped portions. So, revenue is a non-monotonic function of the tax rate (you say it is a quadratic function, maybe so). Now suppose that inflation operates like a tax. That is, people respond to it like a tax. As a result, when this tax is sufficiently high, they work to avoid and evade the tax. In this way, inflation operates as a drag on the economy. This would do it . . . provide an explanation for stagflation.
Best wishes,
Peter
Peter,
You are right that the inflation-related tax increases (cold progression in income tax, but also inflation-related increases in the burden of consumption taxes) are triggering the evasion effects into the shadow economy more intensively and further recessive tendencies in the formal sector, so that stagflation is even worse.
All the best
Hans
I am a bit surprised that this question is coming up at this late date. Decades ago Keynesian models came with a "stuck on" feature, the Phillips curve," which had no real basis in Keynesian analysis. Once Friedman added inflationary expectation to the simple Phillips curve tradeoff between inflation and unemployment it became easy to build Keynesian macro models in which, as inflationary expectations vary using some model of expectations formation, the Phillips curve shifts and can wind up with any inflation rate with a given unemployment rate (including stagflation).
An example of this can be found at https://www.simecon.org/macro2/index.aspx.
While the software involved is now somewhat obsolete the model can be found by clicking on the Instructions button, or by NOT making inflationary expectations constant, the model can be used to produce shifting Phillips curve results. Note the model was created as part of a National Science Foundation project (2001-2005) whose objective was to provide software for undergraduate economics classes. I was one of the two Principal Investigators and created the model.
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