Full Employment Equilibrium Research Articles

Involuntary Unemployment Due to Instability of the Economy and Fiscal Policy for Full-Employment

The existence of involuntary unemployment, proposed by J. M. Keynes, is a very important issue in modern economic theory. Using a three-generation overlapping generations (OLG) model, we show that the existence of involuntary unemployment can be attributed to economic instability. Economic instability is the instability of the difference equation for equilibrium prices around the full employment equilibrium, which means that the presence of involuntary unemployment will further reduce employment when the nominal wage rate declines. This instability is due to the negative real balance effect that occurs when consumers' net savings (the difference between savings and pensions) are smaller than their liabilities, which are calculated by multiplying childhood consumption by the marginal propensity to consume. The paper also presents arguments for fiscal spending and tax cuts by seigniorage, rather than public debt, as a fiscal policy to achieve full employment. This paper presents the theoretical and mathematical foundations of Functional Finance Theory (Lerner (1943), (1944)) and MMT (Modern Monetary Theory, Mitchell, Wray and Watts (2019), Kelton (2020)). It may be an attempt to present the theoretical and mathematical foundations of MMT (Modern Monetary Theory, Mitchell, Wray and Watts (2019), Kelton (2020)).

Towards Money Market in General Equilibrium Framework

This paper aims to integrate the money market into the structure of the economy. The microfoundation is the starting point to define the money market and the general equilibrium mechanism of the economy. On this basis, this research seeks a linking mechanism of the money market with economic activity in the general equilibrium framework. The relationships between money supply and national outcome, inflation, and price level are studied in three cases: full-employment equilibrium economy, steady-state equilibrium economy, and sticky-price equilibrium economy. The research result explains the interrelation and transmission mechanism between the money market and the general equilibrium of the economy. The paper provides the theoretical foundation for further research on the money market and monetary policies towards economic growth and macroeconomic stability.

Expectations and full employment. Hansen, Samuelson and Lange

Les anticipations sont au cœur des premiers modèles de cycles comme de croissance. Dans les années quarante, une troisième ligne de recherche est apparue qui s’interroge sur la capacité des économies à atteindre un équilibre de plein emploi. Cette littérature débute avec la contribution de Hansen [1938] pour atteindre son point culminant avec la publication de l’ouvrage de Lange [1944]. Au fil des débats, la question glisse du problème de l’existence vers celui de la stabilité de l’équilibre de plein emploi, suggérant un rôle croissant des anticipations, allant jusqu’à remettre en cause la stabilité du système économique dans sa globalité. Ce papier retrace ces débats au travers des contributions de Hansen, Samuelson et Lange. L’exploitation des archives nous permet de démontrer que, si l’analyse de l’instabilité est restée très implicite dans les travaux de Samuelson, sa correspondance révèle toutefois qu’il a encouragé Lange à s’intéresser à cette question. Lange présente ses résultats dans son ouvrage de 1944, publié par la Cowles Commission for Research in Economics. Nous montrons que la portée de cette contribution ne peut être comprise indépendamment de ses échanges avec Samuelson ou de la façon dont les idées keynésiennes étaient alors perçues aux États-Unis. Finalement, le papier s’interroge sur le positionnement ambigu de Samuelson tant sur la question de l’instabilité que sur le rôle des anticipations.

Involuntary unemployment in overlapping generations model due to instability of the economy and fiscal policy

The existence of involuntary unemployment advocated by J. M. Keynes is a very important problem of the modern economic theory. Using a three-generations overlapping generations model, we show that the existence of involuntary unemployment is due to the instability of the economy. Instability of the economy is the instability of the difference equation about the equilibrium price around the full-employment equilibrium, which means that a fall in the nominal wage rate caused by the presence of involuntary unemployment further reduces employment. This instability is due to the negative real balance effect that occurs when consumers’ net savings (the difference between savings and pensions) are smaller than their debt multiplied by the marginal propensity to consume from childhood consumption.

Neoliberalismen som dominerende makroøkonomisk diskurs

This paper demonstrates that mainstream General Equilibrium Models (GEM) are dominated by neoliberal ideology. These mathematical models are pre-designed to always converging full-employment equilibrium and private-sector equilibrium. The behavioural equations are derived from the assumption of individual utility and profit maximization and the rational expectation (full foresight) hypothesis. Accordingly, policy recommendations consistent with GEM are neoliberal as they advocate (1) avoiding demand management; (2) balancing the public sector’s (structural) budget; and (3) leaving monetary policy to an independent central bank with responsibility for price stability; while (4) distributional and environmental consequences for production are considered irrelevant. This is illustrated by examples from the Danish macroeconomic environment where GEM (ADAM and DREAM) employed by the Treasury and the Council of Economic Advisors are dominant when it comes to medium and long-term policy recommendations. Finally, the article challenges this logic and objective foundation of mainstream macroeconomics.

(In)stability at the Cowles Commission (1939–1948)

Stability analysis touched off extensive discussions at the Cowles Commission between 1939 and 1948. Oskar Lange, later followed by Lawrence Klein and Don Patinkin, among others, advocated for a move from a static analysis aimed at proving the existence of a stationary equilibrium with unemployment towards a dynamic approach exploring stability properties of full employment equilibria. In presence of excess supply of goods and labour with flexible money wages and prices, the message was that macroeconomic pathologies are better regarded as disequilibrium dynamics when full employment equilibrium is unstable – Lange and Klein – or when it is stable – Patinkin. The objective of this paper is to examine this type of modelling and how it provided the basis of a specific political vision shared by most economists of the Cowles Commission in the 1940’s.

Re-Examination of Modern Macroeconomics: Market Failure in a Walrasian Economy and Keynes's Unemployment Equilibrium

The present study aims to perceive an unacceptable unreality of a macro price mechanism: that is, the unreality that under any severe recession, deterioration of deflation or a consistent decrease in the rate of inflation will lead an economy to full employment equilibrium. This unreality results from an arbitrary assumption that the micro price mechanism operates even in a macro economy. This study challenges the existing modern macroeconomics theories on price mechanism and unemployment based on the skepticism toward existing theories based on the observations of a real economy. The study reveals two main results. First, market failure in a macro economy, that is, the price mechanism is significantly incomplete and does not function, in particular, under deflation. This differs significantly from “the market failure due to the inflexibility of wages and prices, asymmetry of information, and so on,” as stated by new Keynesianism. The key reason for market failure in a short-run macro economy is the unavoidable spillover effects, or derived demand effects between goods and labor markets under disequilibrium due to inflexible wages and prices. Macro price mechanism completely overlooks these effects because of the arbitrary assumption, thus leading to the unrealistic price mechanism stated earlier. Considering the spillover effects, or derived demand effects under disequilibrium, the assumption of full employment equilibrium, along with the assumption of flexible wages and prices, does not hold. Although these effects are the results of the short-run analysis, there would be market failure in a macro economy even in the long run as an inevitable conjecture. To rebuild dynamic stochastic general equilibrium (DSGE) models, it is important to study the aforementioned fundamental and theoretical problem that macro price mechanism does not function. A static model is enough to explain the mechanism and dynamic models appear unnecessary and unfeasible. Second, Keynes’s unemployment equilibrium is realized owing to market failure in a macro economy. Market failure in a macro economy shows that involuntary unemployment results from quantitative and not price aspects. In other words, involuntary unemployment is not a result of the rigidity of real wages but of a shortage in labor demand under rigid real wages. This is possible by reinterpreting the Shapiro–Stiglitz efficiency wage model. Finally, demand is a critical factor in both the short run and the long run.

Implications of Trade Policies in Segmented Factor Markets—A General Equilibrium Approach

This paper, using a three-sector full-employment general equilibrium model with segmented domestic factor markets, explains how and under what conditions a policy of import restriction using tariffs can be beneficial for a small, open economy compared to the import liberalisation policy, contrary to the conventional results. Also, inflows of foreign-owned capital to an export sector within the economy’s export processing zone coupled with labour-augmenting type technology transfer, with protected import-competing sector, can improve national income, even without any distortion in the formal sector labour market. This simple application of competitive trade models establishes the fact that trade restrictions can promote growth and attract FDI for the developing countries, even when foreign capital enters one specific export sector of the economy.

Influence of Economic Stabilization Program Implemented by International Monetary Fund on Economy

This paper investigates the type of economic crises, measures to manage the crises and influence of these measures on economy. Policies are intended to speed up the adjustment process of an economy from imbalance to long-run fullemployment equilibrium. After a scrutiny of the pros and cons of demand side policy and exchange rate policy, the inherent difficulties of achieving multiple objectives in an open economy is seen. The symptoms of crisis occurred in Mongolia would be referred to traditional balance of payment crisis and loan to be offered to Government by the IMF will be support the IMF’s program, which is based on combination of demand and exchange policy. Moreover, some measures of supply side policy will be implemented.

R. Lucas's Research Program: Far Too Narrow with Too Many Special Assumptions

R. Lucas's Research Program: Far Too Narrow with Too Many Special Assumptions

Correcting Modigliani's 1944 'Liquidity Preference and the Theory of Interest and Money': This Article Dealt with Hicks's Interpretation of Keynes, but not with Keynes's General Theory Model

F. Modigliani’s 1944 paper, “Liquidity Preference and the Theory of Interest and Money”, aimed at supplying the missing labor market and production function analysis in Hicks’s 1937 Econometrica paper. However, Modigliani ignored the fact that Keynes had already provided exactly that analysis in chapters 20 and 21 of the General Theory to support his own IS LM analysis from chapters 14, pp.180-182 and chapter 15 pp.199-202 and pp.208-209 of the General Theory. F. Modigliani was an advocate of the personalist, psychological, Bayesian Subjectivist approach to Probability of Ramsey, de Finetti, Savage and Friedman. Modigliani was unable to deal with Keynes’s definition of uncertainty in the General Theory, which was that uncertainty was an inverse function of the weight of the evidence, which Keynes analyzed in chapters 6 and 26 of the A treatise on Probability. Uncertainty means that probability and risk estimates can’t be calculated in an accurate and reliable manner. This would mean that the confidence one has in one’s estimates is important. However, all Subjectivist Bayesians argue that there is no such thing as the confidence that a decision maker has in his probability estimates because the probability estimate is his degree of confidence. Therefore, there can be no such variable that measures the confidence that a decision maker has in the relative strength and/or weakness of the relevant evidence upon which the probabilities are being estimated. The state of confidence can’t be accepted as a variable that will be taken into account by a decision maker. Therefore, liquidity preference must be a function of risk only. A probability distribution is assumed to be known for certain by all decision maker, so that the expected price level will be a precise, exact determinate number. All of these points were rejected by Keynes in the A treatise on Probability and General Theory. In fact, for Keynes the expected price level is imprecise or indeterminate. Therefore, the expected real wage is imprecise or indeterminate. Modigliani’s subjectivist approach to probability results in Modigliani incorrectly specifying the demand for labor function in Keynes’s General Theory by ignoring Keynes’s definition in the General Theory that the demand for labor curve is a function of the expected real wage and not the actual real wage. The actual real wage, (w/p) can’t be specified precisely because workers and employers only know their nominal money wage, w, for certain. p is expected and can only be represented by an interval estimate form of probability. This will automatically lead to multiple equilibria, only one of which will be consistent with Modigliani’s one, unique, stable full employment equilibrium. Modigliani also erred in explicitly assuming that the theory of the firm-industry used in the General Theory was the Theory of Perfect Competition, so that the expected price level, p, is known for certain based on the assumptions of perfect information and perfect prediction. In fact, Keynes used the theory of Pure Competition and expressly made it clear that there were a number of different expected price levels held with varying degrees of probability and definiteness on p.24 in footnote 3 of the General Theory. There was not only one expected value, as assumed by Modigliani. None of Modigliani’s conclusions regarding liquidity preference hold in the Keynesian system analyzed by Keynes in chapters 13-15 and 19-21 of the GT based on uncertainty. Modigliani’s conclusions only hold in his redefined model where risk is substituted for uncertainty, perfect competition is substituted for pure competition, and a known, definite, precise real wage is substituted for Keynes’s expected, imprecise, indeterminate real wage.

No man is an Island: The impact of heterogeneity and local interactions on macroeconomic dynamics

We develop an agent-based model in which heterogeneous firms and households interact in labor and good markets according to centralized or decentralized search and matching protocols. As the model has a deterministic backbone and a full-employment equilibrium, it can be directly compared to Dynamic Stochastic General Equilibrium (DSGE) models. We study the effects of negative productivity shocks by way of impulse-response functions (IRF). Simulation results show that when search and matching are centralized, the economy is always able to return to the full-employment equilibrium and IRFs are similar to those generated by DSGE models. However, when search and matching are local, coordination failures emerge and the economy persistently deviates from full-employment. Moreover, agents display persistent heterogeneity. Our results suggest that macroeconomic models should explicitly account for agents' heterogeneity and direct interactions. Moreover, our results point to the role of quantity adjustments in determining the ability of the economy to return or not to full-employment.

On J. M. Keynes's Initial IS-LM Approach in 1933 and 1934: Its Connection to Liquidity Preference, the Weight of Evidence, the A Treatise on Probability, and Keynes's Aggregate Supply Curve from Chapter 20 of the General Theory

J M Keynes had worked out his own version of IS-LM based on his weight of the evidence analysis from the A Treatise on Probability,1921, in 1933 and 1934 before publishing the General Theory in February,1936.However, he decided not to use it because it had no microeconomic foundations and did not incorporate explicit price and profit expectations in the model for both the LM and IS curves. Instead, Keynes ,in chapter 20 of the General Theory, constructed the mathematical model of his Theory of Effective Demand that was introduced in chapter 3 of the General Theory. Keynes’s major result was his development of his Aggregate Supply Curve, which is a locus of the set of all expected D=Z intersections. Each point on this locus satisfied the necessary and sufficient first and second order conditions for being an expected profit maximum. Thus, the aggregate supply curve is the set of all possible , multiple equilibria in an economy that are optimal. Only one of the possible equilibria will be a full employment equilibrium. All of the remaining equilibria will be under employment or unemployment equilibria .Indirectly, Hicks, Hansen, Harrod and Meade presented various versions that were partly consistent with Keynes’s mathematical model from chapters 20 and 21 in 1937 . Only one came close-James Meade.It is not possible to fully understand Keynes’s own, original version of the IS-LM curves unless a reader can follow the explicit links made by Keynes in the General Theory to Keynes ‘s analysis of the weight of the argument (evidence) in the A Treatise on Probability . Keynes’s analysis of Liquidity Preference ,based on Keynes’s explicit definition of uncertainty as being an inverse function of weight alone on p.148 of the General Theory, was tied by Keynes to Liquidity preference as behavior toward uncertainty.No economist, especially of the Post Keynesian or Institutionalist type , accepted Keynes’s very clear cut definition that Uncertainty is an inverse function of weight alone.Therefore, this failure to comprehend the concept of weight by economistsexplains why no economist was able to realize that Keynes was the creator of hisown ,original version of the IS-LM model.All economists ,who use the IS-LM model, are thus Keynesians of one degree oranother .Of course ,many economists have their own version of the IS-LM modeland are not able to see the direct connection between the weight of evidence andLiquidity Preference because they do not understand Keynes's logical theory of Probability.

THE PHILLIPS CURVE AND AN ASSUMED UNIQUE MACROECONOMIC EQUILIBRIUM IN HISTORICAL CONTEXT

An early post-WWII debate concerned the most desirable demand and inflationary pressures at which to run the economy. Context was provided by Keynesian theory devoid of a full employment equilibrium and containing its mainly forgotten, but still relevant, microeconomic underpinnings. A major input came with the estimates provided by the original Phillips curve. The debate seemed to be rendered obsolete by the curve’s expectations-augmented version with its natural rate of unemployment, and associated unique equilibrium GDP, as the only values consistent with stable inflation. The current behavior of economies with the successful inflation targeting is inconsistent with this natural-rate view, but is consistent with evolutionary theory in which economies have a wide range of GDP-compatible stable inflation. Now the early post-WWII debates are seen not to be as misguided as they appeared to be when economists came to accept the assumptions implicit in the expectations-augmented Phillips curve.

A note on the sustainability of full employment in the presence of budget deficits

ABSTRACTIn a recent issue of this journal, Tymoigne and Wray, as well as Palley, discussed whether economies can experience stable full-employment equilibria with persistent public budget deficits. This implies continuous growth of a stock-variable: high-powered money and/or government bonds in the hands of the private sector. Their discussion assumed a stationary state. The question is whether such a situation can be regarded as sustainable over time. This paper argues that a satisfactory solution to the problem can be found only by abandoning the hypothesis of stationary state and considering the effects that different compositions of public expenditure have on the rate of growth. To have a stable full-employment equilibrium with budget deficits, the economy must grow. Since the economy is assumed to be in full employment, the growth of aggregate output must be entirely due to the growth of productivity, which can be realized by changing the composition of public spending in favor of productive expenditures.

New macroeconomics teaching for a new era: instability, inequality, and environment

The financial crisis of 2008 and its aftermath offer an opportunity to institute significant reform in economics teaching, starting at the introductory level. Mainstream macroeconomics texts still rely heavily on a classical assumption of a long-run full employment equilibrium, which underrates the possibility, severity, and duration of economic crises. They have little treatment of inequality, virtually no consideration of its macroeconomic effects, and pay almost no attention to the environment. A better approach starts with the use of a dynamic AS/AD model, with inflation rather than the price level on the vertical axis, avoiding the spurious implication that there is some stable price level at which the entire macroeconomy will reach equilibrium. With this approach, there is no presumption that the economy will automatically return to a situation of full employment. Rather, there is an important role for conscious fiscal and monetary policy. In this context, it becomes possible to discuss how economies can be characterized by different equilibria and disequilibria, varied growth paths with different environmental impacts, and inherent instability. The analysis can be used to illustrate recent and historical shifts in the economy and economic policy responses. While not necessarily tied to the concept of a ‘green economy,’ a more dynamic analysis is strongly compatible with an environmental interpretation of macroeconomics, including environmental policy to respond to global climate change and other problems.

Comparative Interpretation of Classical and Keynesian Fiscal Policies (Assumptions, Principles and Primary Opinions)

Adam Smith being its founder, in the Classical School, which gives prominence to supply and adopts an approach of unbiased finance, the economy is always in a state of full employment equilibrium. In this system of thought, the main philosophy of which is budget balance, that asserts that there is flexibility between prices and wages and regards public debt as an extraordinary instrument, the interference of the state with the economic and social life is frowned upon. In line with the views of the classical thought, the classical fiscal policy is based on three basic assumptions. These are the "Consumer State Assumption", the assumption accepting that "Public Expenditures are Always Ineffectual" and the assumption concerning the "Impartiality of the Taxes and Expenditure Policies Implemented by the State". On the other hand, the Keynesian School founded by John Maynard Keynes, gives prominence to demand, adopts the approach of functional finance, and asserts that cases of underemployment equilibrium and over-employment equilibrium exist in the economy as well as the full employment equilibrium, that problems cannot be solved through the invisible hand, that prices and wages are strict, the interference of the state is essential and at this point fiscal policies have to be utilized effectively.Keynesian fiscal policy depends on three primary assumptions. These are the assumption of "Filter State", the assumption that "public expenditures are sometimes effective and sometimes ineffective or neutral" and the assumption that "the tax, debt and expenditure policies of the state can never be impartial".

Anti-Keynesian Views: Fiscal and Monetary Guidelines

AbstractIn this article, we will cover the main anti-Keynesian views and macroeconomic systems that arose in the post Keynes period as well as their fiscal and monetary policy guidelines. As is known, the early Classical economists introduced a macroeconomic system based on the Quantity Theory and Say’s Law resulting in automatic full-employment equilibrium; and finally after 1929-1934 Great World Depression, the Keynesian System was introduced as a “revolution” (Keynesian Revolution) in theory and practice. As a result of the Keynesian policies implemented, European countries and the United States not only got over the Great World Depression but also in the years following the World War II, they have observed a fast and stable growth for a long time. Moreover, cyclical fluctuations have been controlled to a great extent. Even so, at the stage when the Keynesian System was introduced, anti-Keynesian views and macroeconomic systems were immediately introduced. Intense academic discussions between advocates of these views and the Keynesian economists have continued up until today. Meanwhile, many economists such as J.R. Hicks, R.F. Harrod, N. Kaldor, M. Kalesci, A.W. Philips, A. Hansen, P.A. Samuelson, E. Domar, J. Tobin, R. Solow, A.M. Okun, W. Helier, G. Ackler, F. Modigliani, and R. Musgrave and many others have developed and defended the Keynesian System from different aspects. We can characterize significant anti-Keynesian views and macroeconomic systems as the “Counter-Revolution”.

Animal spirits and unemployment: a disequilibrium analysis

The past decade has seen a number of advances in modelling disequilibrium dynamics. This paper draws on separate approaches to disequilibrium dynamics to demonstrate a Keynesian result concerning the formal relevance of “animal spirits” in production economies. Specifically, it is shown that a parameter that can be associated with the “animal spirits” of firms is crucial to the stability of full employment equilibrium in a production economy. This approach to “animal spirits” is different to that taken by recent New Keynesian DSGE-type models, but similar in spirit to “Old Keynesian” approaches, including that of the General Theory. The corollary of the main conclusion is that price flexibility is not a sufficient condition for convergence on full employment equilibrium.

The Policy Consensus Ruling European Political Economy: Its Attractions, Flaws and Possible Departures

Since 2008, crises in financial markets have forced governments in OECD countries to unprecedented monetary and fiscal intervention. In previous such situations, namely the Great Depression and stagflation in the 1970s, the economic policy consensus of the time came under close scrutiny and eventually shifted. Today, criticism of academic economics is not in short supply but a straightforward alternative is not in sight either. This seems to be particularly troubling for governments in Europe, desperate for advice on how to stop contagion spreading from a small peripheral economy to the core of the European Union. But then, the lessons that especially European governments seem to draw from the crisis suggest that the economic policy consensus of the last two decades, with its heavy emphasis on structural reforms and inflation-targeting monetary policy, is less obsolete than the critics suggest. Our contribution first assesses what the consensus until recently has been and how it could have been implicated in the crisis. We identify as the elements of the consensus that are potentially flaws responsible for the crisis the notion of a fundamental equilibrium that is determined independently of financial markets, the focus on micro foundations that neglects issues of systemic stability and an obsession with structural reforms of labour markets. The incremental shift of economic theorizing towards selfregulation of markets and macro-stabilisation assigned to central banks left governments the task of restoring the role of the price mechanism in labour and product markets. A stronger role of price adjustments increased the flexibility of nominal prices but not necessarily real adjustment. Second, we argue that the policy consensus continues to persist because it is politically attractive. Following Hall (1989) who suggested that ‘the political power of economic ideas’ requires, at a minimum, their economic, administrative and political viability, we identify the attractions of the policy consensus as directly following from its theoretical flaws. In monetary policy, agencification of monetary policy - i.e. the creation of independent central banks - freed fiscal authorities from dealing with issues of macro-stabilisation for which they typically get more blame than praise. The assurance that there is a full-employment equilibrium determined by real economic factors enabled governments to turn a blind eye on overheating credit markets that allowed households to finance rising consumption while real incomes stagnated for most. Finally, the focus on labour markets and structural reforms suited particularly centre-left parties and governments targeting changing electoral constituencies, due to a decline in industrial employment and the inequality of employment conditions in services. We end the paper with observations of potential departures from the policy consensus that could indicate a significant shift for the political economy of Europe. The crucial question is whether political support can be mobilized for the shift from structural reforms of labour markets to the containment of risks in financial markets. Welfare state building in the 20th century depended on the active support of firms for welfare state expansion in the employment relationship. Similarly, robust re regulation of financial markets is likely to emerge as a response to political demand by ‘capitalists against markets’ (Swenson 2002). One cannot take this demand for granted. But we argue that there is a prospect for the formation of politically cross-cutting coalitions that aim at defending the real economy against financial havoc by protecting the financial system from itself.