Compact GEM Narrative

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Last week’s post reviewed a number of consequential innovations of the GEM Project. This week provides a companion piece, a bare-bones summary the generalized-exchange narrative. Good theories accommodate compact descriptions. What follows outlines, in just over 400 words, the GEM Project’s micro-coherent general-equilibrium workplace-marketplace synthesis that is the wellspring of those useful innovations.

Generalized-exchange modeling bifurcates both households and firms, each of which rationally pursues self-interests governed by axiomatic preferences and technology. Households are constrained by heterogeneous endowments of financial assets. For the largest class, earnings from wealth do not contribute to household income; in the much smaller share of households, financial assets are the source of income. More crucially, firms are separated into two venues that reflect size-related heterogeneity, arising from specialization, the nature of workplace information, and routinized jobs. Organizational diversity in the modern production of goods and services is fundamental.

Labor is point-of-hire homogeneous; Harris-Todaro transfer governs inter-venue worker flows. Generalized exchange locates large-establishment-venue (LEV) labor pricing in the workplace, where profit-maximizing firms construct exchange mechanisms and must pay the continuous-equilibrium efficiency wage (WnJ) that equals rational employees’ reference wage (WńJ). The fundamental equality notably microfounds meaningful wage rigidity (MWR), which uniquely induces rational causation from aggregate nominal-demand disturbances to involuntary job loss and recognizably-sized movement in employment, output, and income. Meanwhile, small-establishment-venue (SEV) firms can do no better than paying workers’ opportunity cost, i.e., the market wage (Wm).

Macrodynamics are crucially enriched by rational MWR, which suppresses wage recontracting and pushes workers off their labor-supply schedule. Keynes’s Second Classical Postulate and Wicksell-Wicksteed income distribution are both scrapped in LEV modeling. Income and wealth become the primary determinants of consumption, and expectations of pure profit principally influence investment. Interest rates play secondary roles in each, while coherent hold-up problems are critically introduced into production-capacity management. Stationary spending disturbances are associated with temporary layoffs, while persisting nonstationary demand shocks generate, after substantial lags, permanent job downsizing as well as rationally recalibrated worker reference standards and wage givebacks. Unemployment follows a continuous-equilibrium macro-dynamic path. Labor is employed in rationed rent-paying LEV jobs or readily-available market-wage SEV jobs, involuntarily or voluntarily unemployed, or voluntarily out of the labor force. Job quits are procyclical and play no significant role in the stabilization narrative. Consistent with the relevant evidence, job-matching efficiency also does not much matter, insignificantly influencing employment fluctuations.

Rational exchange in LEV workplaces produces dominant labor pricing and job rationing that constrain optimization in the marketplace, reconciling continuous decision-rule equilibrium and supply-demand disequilibrium. In the simplest TVGE version, all rational exchange, except between LEV employers and employees, occurs in the marketplace and is largely governed by familiar textbook analysis. The fundamental message, once the model pieces are assembled, is definitive. Macroeconomics that is simultaneously micro-coherent and stabilization-relevant is not feasible absent MWR and, consequently, the generalization of rational, price-mediated exchange.

Blog Type: Wonkish Saint Joseph, Michigan

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