DYNAMIC INTERACTIONS BETWEEN THE PHILLIPS RELATION AND THE IS-LM MODEL

Abstract

In this paper the IS‐LM model is extended dynamically by the addition of a price‐adjustment relation (the Phillips relation) and a quantity‐adjustment relation. Three specifications of the Phillips relation are considered. It is shown that the nature of the price‐adjustment process has important implications for stability; in fact the price‐adjustment processes which yield clockwise (counter‐clockwise) Phillips loops may also be unstable (are not unstable). On the other hand, the speed of the price‐adjustment process is not relevant for stability. The speed of quantity adjustment is only important in the expectations case and there the slower the speed of adjustment the more likely is instab..