A THEORETICAL ANALYSIS OF STRUCTURAL DISEQUILIBRIUM, SECTORAL SHOCKS, AND THE DESIRABILITY OF MONETARY AND FISCAL POLICY INTERVENTIONS (INFLATION, WELFARE, WAGE RIGIDITY)

This thesis is concerned with analysis and interpretation of macroeconomic phenomena within a framework which explicitly accounts for the micro-macro linkages and allows for a micro to macro feedback mechanism. This alternative framework enables us to evaluate various implications of policy intervention in view of the nature and source of the initial shock to the system, and the initial conditions at the time of the shock. The approach is based on modeling the sectoral (allocative) impact of the M and F stabilization tools in the presence of structural disequilibrium (SD) and sectorally biased shocks (SBS) under the assumption of sluggish wage and price adjustment and positive costs of factor mobility. This approach to macro analysis facilitates better understanding of the dynamics underlying the macro phenomena and explains observations such as stagflation, fluctuations, and slow growth.; It is shown that policy intervention in the presence of (SD) and/or (SBS) prevents smooth adjustment in markets experiencing current disequilibrium, leading to the accumulation of the disequilibrium components and the divergence of the relative rate of return of various factors from their underlying equilibrium values. This lead to the magnification of disequilibrium, thus accentuating the initial fluctuation or creating new fluctuation. Moreover, it is shown that any expansionary policy designed to reduce the level of unemployment below the level determined by the underlying market conditions, will result in further fluctuation in the form of stagflation. This result holds even if the current level of unemployment is at or greater than the natural rate level, and even in the presence of accelerating inflation.; The welfare, growth, and other efficiency implications of active policy intervention are also examined. It is found that active stabilization in the presence of (SD) or (SBS) will generate net welfare costs, reduce the rate of implementation of new technologies and the rate of growth, and increase the natural rate of unemployment. Stagflation is shown to result from unexpected shifts in the relative (to GNP) size and composition of the government budget.; The relevant structural characteristics of the economy are also considered. Downward wage rigidity and the asymmetry in upward and downward flexibility of wages and prices are further explained based on the maximizing behavior of agents and the characteristics of the market place. The existence of inherent inflationary or deflationary biases in the system, and of structurally induced Phillips trade-off are also investigated under alternative states of the world.