Abstract
This article questions the thesis (again in fashion) that, in an advanced economy, price flexibility ensures full employment. (See most standard macro textbooks.) We make the point that explanation of unemployment in terms of price/wage stickiness typified much pre-Keynesian analysis, but not Keynes's theory of involuntary unemployment. Under uncertainty—an essential part of the Keynesian conception—no set of prices consistent with full employment may actually exist: if so, price inflexibility is not the critical obstacle to the attainment of full employment. Finally, with respect to current use of the aggregate demand/aggregate supply (AD/AS) model, we note that once-rejected ideas have returned to the mainstream and that strong arguments against the attribution of necessarily beneficial effects to price and wage flexibility, which ought to be well-known, seem now to be forgotten, Mainstream macroeconomics today is in danger of losing touch with reality.
Highlights
At the present time, standard macro textbooks are wont to convey the view that the “natural” state of the economy is one of full employment, and that unemployment, when it occurs, be considered a temporary, disequilibrium phenomenon resulting from stickiness of prices and consequent slowness of the market mechanism in performing its equilibrating role
We conclude, is paid to the possibility that, even with wage and price flexibility, such adjustments may be incapable of reconciling demand and supply throughout the economy so as to generate full employment
The problem may be of a more fundamental nature than one of mere stickiness of prices which prevents the ready attainment of an existing set of market clearing values. It may well be the case, in a world of uncertainty, with saving and investment, that, in given circumstances, no set of equilibrium prices exists to be reached through the free functioning of the price mechanism: the problem is not that prices fail to adjust, but that the state of aggregate demand is incompatible with the conditions of labour supply
Summary
Standard macro textbooks are wont to convey the view that the “natural” (default) state of the economy is one of full employment, and that unemployment, when it occurs, be considered a temporary, disequilibrium phenomenon resulting from stickiness of prices and consequent slowness of the market mechanism in performing its equilibrating role. One refers to stickiness of relative prices, and the other to inflexibility of the general price level; both associate the Keynesian tradition with non-adjustment of prices, and both associate the persistence of unemployment with inadequate price adjustment. One refers to the price of labour (the real wage rate), the other to the general level of prices
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