Paradox of Hysteresis and Real-Wage Flexibility in Australia

Abstract

This study examines the paradoxical coexistence of high unemployment rates and real-wage flexibility in Australia during the period 196692. The neoclassical paradigm postulates that real-wage flexibility is a prerequisite for the economy to operate at the natural rate or full employment level of output. The Keynesian paradigm blames tfie downward stickiness of nominal wages for the prevalence of unemployment in an economy. However, both paradigms agree that the divergence of the unemployment rate from the natural rate is only a short-run phenomenon and that in the long run it reverts to the natural rate. New Keynesians and Neo-Keynesians, while dissenting on the speed of reversal, agree with the long-run natural rate outcome postulated by the dominant paradigms (Cross, 1988; Davidson, 1993). The concept of NAIRU (nonaccelerating inflation rate of unemployment) attempts to synthesize the conflicting paradigms and to explain the nonreversal to the natural rate in terms of socioeconomic policy variables (Layard et al., 1991). The nonreversal of the unemployment rate to the natural rate and consequent persistence of unemployment has a vague similarity to the well-defined properties of remanence and selective memory associated with the concept of hysteresis in physics. These properties of hysteresis are generated by loading and unloading of nonlinear multibranch inputoutput systems with heterogeneous elements (Krasonsel'skii and Pokorovoskii, 1989; Mayergoyz, 1991). The presence of unit roots or zero eigenvalue dynamics in the unemployment rate time series shows, first, that the current unemployment rate depends on the past rates; second, that a shock can lead to a permanent change or nonmean reversion because of the absence of a unique equilibrium. Such characteristics of unit roots are consistent with