The Aggregate Supply Curve: Keynes and Downwardly Sticky Money Wages

Abstract

Keynes opened his General Theory of Employment, Interest and Money with a number of well-argued point-by-point rejections of the tenets of the classical theory of employment, the theory that held that the supply and demand for labor automatically positions the economy at a unique full-employment equilibrium. With orthodox theory cleared away in Chapter 2, Keynes devoted the remaining chapters of his book to the explication of his own revolutionary theory of employment (Davidson, 1984). Of the several charges Keynes levied against orthodox theory, one in particular has been subject to much misunderstanding and needless argumentation. The particular criticism I refer to is Keynes's outright dismissal of the classical labor supply function on the grounds that money wages are downwardly stickythat in fact money wages are not perfectly flexible, as assumed in classical theory. Elementary and intermediate textbook authors have generally acknowledged the correctness of Keynes's view that money wages are downwardly sticky. However, these authors do not explain why money wages are sticky, nor do they incorporate the full significance of sticky wages into their analyses of the aggregate supply curve. Consequently, their full macroeconomic models are incorrectly specified, and the conclusions they draw concerning the response of prices and wages to prior changes in aggregate demand are apt to be misleading or incorrect. In the first part of this paper, I briefly review Keynes's explanation of both the rationale underlying downwardly sticky money wages and the consequences this phenomenon has for macroeconomic theory. In the next section, I contrast the textbook treatment of the aggregate supply curve with one that is more appropriate to the economy in which we live, an economy in which money wages are downwardly sticky.