Money-Wage Dynamics and Labor-Market Equilibrium

Abstract

This chapter discusses money-wage dynamics and labor-market equilibrium. A generalized excess-demand theory of the rate of change of the average money-wage rate has been developed for frictional labor markets that allocate heterogeneous jobs and workers without having perfect information and market clearance by auction. There are two explanatory variables: the vacancy rate and the unemployment rate. The unemployment rate and the rate of change of employment are shown to be joint proxies for the vacancy rate. Hence, generalized excess demand can be regarded as a derived function of the unemployment rate and the rate of change of employment. This relationship is the augmented Phillips curve. Some of its properties are deduced. Equilibrium entails equality between the actual and expected rates of wage change. The steady-state equilibrium locus is implied to be a vertical line at a unique steady-state equilibrium unemployment rate. This is consistent with the usual theory of anticipated inflation. But if there are downward money-wage rigidities, then, up to a point, every one percentage point increase of the expected rate of wage change produces less than a one percentage point increase of the actual rate of wage change. The steady-state equilibrium locus will then have the characteristic negative slope of the Phillips curve in the range of large unemployment rates. But at sufficiently small unemployment rates, equilibrium is impossible and under the adaptive expectations theory, an explosive hyperinflation will result.