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Wage Flexibility and Unemployment: The Keynesian Perspective Revisited

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Keynes' main concern in the General Theory is about the capacity of an economy to return to a full employment equilibrium when subject to a (negative) demand shock. He maintains that money wages cuts may not help reabsorb unemployment, as they do not necessarily imply a fall in real wages. On the contrary, wage rigidity may be necessary for avoiding that a cumulative process propels the economy far away the full employment equilibrium. The consideration of co-ordination failures in the investment-saving market is behind this conclusion. However, the analysis is carried out within a static equilibrium framework.This paper is an attempt to focus on the problems of intertemporal co-ordination arising within the context of a sequential economy. Our analysis of the out-of-equilibrium process of adjustment stirred by a shock of whatever nature allows to generalize the original Keynesian intuition. It shows in fact that unemployment emerges as the result of a lack of co-ordination due to irreversibly constrained choices, and that not only nominal but also real wage flexibility does not necessarily help to restore equilibrium. As a matter of fact, it may even be harmful, by triggering processes that make the economy diverge from equilibrium. The analysis carried out has important analytical implications as regards the role of market imperfections and the interpretation of the effects of monetary policy.

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Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2001-02.

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Date of creation: 2001
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Publication status: Forthcoming in the Scottish Journal of Political Economy
Handle: RePEc:fce:doctra:0102

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Keywords: co-ordination; unemployment; wage rigidity; Keynesian economics;

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  1. d’ASPREMONT, C. & DOS SANTOS FERREIRA, R. & GERARD-VARET, L.-A., 1986. "On monopolistic competition and involuntary unemployment," CORE Discussion Papers 1986035, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Hicks, John, 1989. "A Market Theory of Money," OUP Catalogue, Oxford University Press, number 9780198287247, September.
  3. Cooper, Russell & John, Andrew, 1988. "Coordinating Coordination Failures in Keynesian Models," The Quarterly Journal of Economics, MIT Press, vol. 103(3), pages 441-63, August.
  4. DREZE, Jacques H., 1997. "Walras-Keynes equilibria coordination and macroeconomics," CORE Discussion Papers 1997051, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Francesco Saraceno, 2004. "Wage Regimes, Accumulation and Finance Constraints: Keynesian Unemployment Revisited," Documents de Travail de l'OFCE 2004-01, Observatoire Francais des Conjonctures Economiques (OFCE).
  6. Silvestre, Joaquim, 1993. "The Market-Power Foundations of Macroeconomic Policy," Journal of Economic Literature, American Economic Association, vol. 31(1), pages 105-41, March.
  7. James Tobin, 1993. "Price Flexibility and Output Stability: An Old Keynesian View," Journal of Economic Perspectives, American Economic Association, vol. 7(1), pages 45-65, Winter.
  8. Hart, Oliver, 1982. "A Model of Imperfect Competition with Keynesian Features," The Quarterly Journal of Economics, MIT Press, vol. 97(1), pages 109-38, February.
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Cited by:
  1. Jean-Luc Gaffard, 2008. "Innovation, competition, and growth: Schumpeterian ideas within a Hicksian framework," Journal of Evolutionary Economics, Springer, vol. 18(3), pages 295-311, August.
  2. Francesco Saraceno, 2004. "Wage Regimes, Accumulation and Finance Constraints: Keynesian Unemployment Revisited," Documents de Travail de l'OFCE 2004-01, Observatoire Francais des Conjonctures Economiques (OFCE).
  3. Jean-Paul Fitoussi & Eloi Laurent, 2008. "North by Northwest: What’s Wrong with the French Model and How Can the Nordic Model Help," Documents de Travail de l'OFCE 2008-18, Observatoire Francais des Conjonctures Economiques (OFCE).
  4. Mauro Napoletano & Giovanni Dosi & Giorgio Fagiolo & Andrea Roventini, 2012. "Wage Formation, Investment Behavior and Growth Regimes: An Agent-Based Analysis," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(5), pages 235-261.
  5. Jean-Paul Fitoussi & Eloi Laurent, 2009. "Macroeconomic and social policies in the EU 15 : the last two decades," Documents de Travail de l'OFCE 2009-20, Observatoire Francais des Conjonctures Economiques (OFCE).
  6. Jean-Luc Gaffard & Francesco Saraceno, 2007. "International Trade and Domestic Distortions: Modelling the Transition Process," Documents de Travail de l'OFCE 2007-18, Observatoire Francais des Conjonctures Economiques (OFCE).

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