Regional Wage and Price Dynamics

Most regional economic models are based on levels and real balances. For example, firms’ employment decisions are thought to be a function of local relative wages (relative to the wage levels of other places) discounted by local price levels and labor productivity. Such models are based on comparative statics and reduce decision variables to their “real” values, supposedly untainted by monetary effects. This modeling strategy is appropriate if the spatial economic system is at equilibrium. At equilibrium, we do not need to know how the economic system gets from one point to another, or how economic agents are going to respond to changes in the economic environment. These issues are irrelevant in a world that is stable, certain, and complete.’ In a world characterized by disequilibrium, however, different issues arise. It is very important to understand how the economic system adapts and adjusts (Benassy 1982). Levels are not so important as changes, and money effects are very important, rivaling real balances in terms of their influence on output and employment (Tobin 1980). Not only are money variables decision variables, in a world of uncertainty they are also the approximate variables for the underlying economic structure. Once the comfortable world of certainty and equilibrium is left behind, the crucial issue becomes the temporal relationships between variables. In this paper we analyze the temporal relationships between regional money wage and price inflation. Assuming that disequilibrium best characterizes the spatial economy, we also assume that money wages are a crucial behavioral variable, being a proximate measure of labor’s income and firms’ costs. Prices, though also vital, are not so obviously endogenous decision variables. Price inflation *Research reported here was funded in part by a grant from the German Marshall Fund of the United States. The first draft of this pa r was written while Gordon Clark was a guest of the ORL Institute of Eidgenossische Technische Hocgchule, Zurich, Switzerland. Thanks to B. Hotz-Hart, M. Hotz-Hart, and John Whiteman for comments on a previous draft. All opinions and errors, if any, are, of course, those of the authors. ‘Indeed, equilibrium models are singularly ill equipped to handle out-f-equilibrium situations. As Hahn (1973) noted, equilibrium models “make no formal or explicit causal claims at all. Such models] . 7). Both neoclassical economics and some variants of radical economic theories are compromised by $l ese problems.