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  Keynes’ Rejection of Wage Rigidity

  By James Annable | Dec 8, 2023

  This post addresses a long-standing curiosity in macroeconomics that is especially relevant to the GEM Project. Why did Keynes reject a role for nominal wage rigidity (WR) in his explanation of involuntary job loss? From The General Theory (1936): “There is therefore no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment…. The economic system cannot be made self-adjusting along these lines.” It should, of course, be noted upfront that Keynes’ rejection was always made suspicious by his critical use of WR in his actual modeling of mass unemployment.

  In what follows, the GEM Project’s generalization of rational exchange from the marketplace to information-challenged workplaces helps make sense out of Keynes’ attempt to understand involuntary job loss (IJL) absent WR. The story turns on two central objectives of the great theorist in the propagation his macro revolution. First, he very much wanted his new theory to preserve the classical infrastructure of general market equilibrium. Second, he wanted to steer clear of wage cutting as a policy response to mass IJL.

  Given those objectives, Keynes’ WR snub is ultimately rooted in the nature of economic theory when he wrote The General Theory. Simply put, he lacked analytic tools sufficient to rationally model IJL. From De Vroey (2016): “Keynes could simply accomplish no more than what was possible given the state of economic theory at the time. The program he pursued was extremely ambitious, more than he realized, and he lacked the means to achieve it….  In other words, he perceived that involuntary unemployment should be accounted for in general equilibrium terms (although he did not use this expression); but its origin had to be sought in other parts of the economy than the labor market.”

  The GEM Project, with its focus on employer-employee exchange that rationally occurs...

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