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Behavioural Macroeconomics And Wage And Price Setting: Developing Some Early Insights Of John Maynard Keynes And Joan Robinson

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  • Ian McDonald

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Abstract

This paper argues that the theory of wage and price setting in macroeconomics should be broadened to include insights from behavioural economics, in particular prospect theory and loss aversion. The paper shows how broader microeconomic foundations can explain the main features of a realistic Phillips curve, which are the concurrence of a steep SRPC at low unemployment, a flat SRPC at high unemployment and speed-limit effects. The resulting macroeconomic model has the benefits of consistency with important properties of natural rate models, especially a crucial role for inflation expectations and, in determining the economy’s macroeconomic potential, for supply factors, plus the benefit of consistency with the standard IS/LM model. The paper also shows that the behavioural aspects of these broader microeconomic foundations were alluded to by Keynes and Robinson in 1936 when macroeconomics was created.

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Bibliographic Info

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2009-11.

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Length: 37 pages
Date of creation: Aug 2008
Date of revision:
Handle: RePEc:een:camaaa:2009-11

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  1. Ian McDonald & Jenny Lye, 2006. "Union Power and Australia’s inflation Barrier, 1965:4 to 2004:3," Australian Journal of Labour Economics (AJLE), Bankwest Curtin Economics Centre (BCEC), Curtin Business School, vol. 9(3), pages 287-304, September.
  2. Sibly, Hugh, 2002. "Loss averse customers and price inflexibility," Journal of Economic Psychology, Elsevier, vol. 23(4), pages 521-538, August.
  3. Robert Lucas & Mike Golosov, 2004. "Menu Costs and Phillips Curves," 2004 Meeting Papers 144, Society for Economic Dynamics.
  4. Gordon, Robert J, 1996. "The Time-varying NAIRU and its Implications for Economic Policy," CEPR Discussion Papers 1492, C.E.P.R. Discussion Papers.
  5. Lye, J N & McDonald, I M & Sibly, H, 2001. "An Estimate of the Range of Equilibrium Rates of Unemployment for Australia," The Economic Record, The Economic Society of Australia, vol. 77(236), pages 35-50, March.
  6. George A. Akerlof, 2007. "The Missing Motivation in Macroeconomics," American Economic Review, American Economic Association, vol. 97(1), pages 5-36, March.
  7. Krugman, Paul, 2000. "How Complicated Does the Model Have to Be?," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 33-42, Winter.
  8. Woglom, Geoffrey, 1982. "Underemployment Equilibrium with Rational Expectations," The Quarterly Journal of Economics, MIT Press, vol. 97(1), pages 89-107, February.
  9. Christina D. Romer, 1996. "Inflation and the Growth Rate of Output," NBER Working Papers 5575, National Bureau of Economic Research, Inc.
  10. Douglas Laxton & Guy Debelle, 1996. "Is the Phillips Curve Really a Curve? Some Evidence for Canada, the United Kingdom, and the United States," IMF Working Papers 96/111, International Monetary Fund.
  11. Daniel Kahneman & Jack L. Knetsch & Richard H. Thaler, 1991. "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter.
  12. N. Gregory Mankiw, 2006. "The Macroeconomist as Scientist and Engineer," NBER Working Papers 12349, National Bureau of Economic Research, Inc.
  13. Luigino Bruni & Robert Sugden, 2007. "The road not taken: how psychology was removed from economics, and how it might be brought back," Economic Journal, Royal Economic Society, vol. 117(516), pages 146-173, 01.
  14. Ian M. McDonald & Hugh Sibly, 2005. "The Diamond Of Macroeconomic Equilibria And Non-Inflationary Expansion," Metroeconomica, Wiley Blackwell, vol. 56(3), pages 393-409, 07.
  15. Peter Henle, 1973. "Reverse collective bargaining? A look at some union concession situations," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 26(3), pages 956-968, April.
  16. Edmund S. Phelps, 1968. "Money-Wage Dynamics and Labor-Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 76, pages 678.
  17. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  18. Gordon, Robert J, 1990. "What Is New-Keynesian Economics?," Journal of Economic Literature, American Economic Association, vol. 28(3), pages 1115-71, September.
  19. Linda Babcock & George Loewenstein, 1997. "Explaining Bargaining Impasse: The Role of Self-Serving Biases," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 109-126, Winter.
  20. McDonald, Ian M & Solow, Robert M, 1981. "Wage Bargaining and Employment," American Economic Review, American Economic Association, vol. 71(5), pages 896-908, December.
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