A Model of Output, Employment, Capital Formation and Inflation

This paper reports the theoretical development of a small aggregative model of output, employment, capital formation and inflation. The model (which we subsequently refer to as BHP) is designed to explain medium term cyclical growth in a small open economy. It allows explicitly for disequilibrium in the markets for goods and labour services and has a wage-price sector in which the movements in these variables are specified to allow for intended price setting behaviour by firms while, in addition, responding to realisations which may differ from these intentions as well as responding to the effects of disequilibrium in the real sector. The model is formulated in continuous time as a system of non-linear differential equations and has a particular solution which corresponds to plausible steady state growth behaviour for the variables of the model. The properties of this particular solution are analyzed directly, and solution trajectories for the variables corresponding to various initial values which deviate from the steady state growth paths are computed numerically and compared with the steady state growth paths. The model has been developed with a view to subsequent empirical application to a small open economy and, as a foundation for later work, some econometric methodology for the treatment of non-linear differential equations is developed in the paper