Involuntary job loss is at the heart of the conundrum macroeconomics that plagues mainstream theorists, Policymakers know that the socioeconomic problems of employment and income loss are central to business-cycle pathology. The GEM Project has shown, contrary to many critics of modern modeling, that limitations on the New Keynesian capacity to accommodate actual joblessness do not result from rules of engagement that mandate rational behavior. The germane problem is much less profound, grounded in the arbitrary, nonintuitive restriction of optimizing exchange to the marketplace, and is readily corrected. The solution requires microfounding intuitive stabilization policy rooted in wage rigidity and demand disturbances, preserving the formal economic method rooted in optimization and equilibrium. The critic of the formal economic method with the biggest megaphone is Paul Krugman (2009, p.37): “… economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic ‘theory of everything’ is a long way off.” (Akerlof and Shiller (2009) and Caballero (2010) have also notably critiqued of the keystone role of economic rationality.)
The careful analysis of venues of price-mediated exchange provides the most effective solution to conundrum economics. In the GEM Project, economic venues are defined by fundamental heterogeneities in optimizing decision rules, constraints, and exchange mechanisms that impose boundaries on meaningful aggregation. The venue concept has been used to construct the Two-Venue Theorem:
The existence of continuous optimizing economic equilibrium providing both analytic coherence and wage rigidity sufficient to support involuntary job loss implies the coexistence of market and nonmarket venues of rational price-mediated exchange, with the latter governing the dominant subset of labor pricing.
The bedrock theorem may be best understood in conjunction with Barro’s well-known wage-recontracting critique. It is offered, not modestly, as the most consequential labor theorem in macroeconomics. Its exploration has notably produced the first modern theory of wage determination. Pulling the profession’s understanding of labor pricing out of the 19th century, where it is universally understood by practitioners to no longer belong, is a good thing.
Limits to aggregation help build the case that modeling restricted to single-venue (marketplace) exchange inadequately supports stabilization-relevant macro theory. That argument has always rung true. The fact of forced layoffs implies the existence of wage rigidity, which in turn implies the existence of wage rents and job rationing, suppression of work-leisure substitution, nominal non-neutralities, and spillover effects that disturb other markets. Such a macro environment, much more Keynesian than Walrasian, is an uncomfortable fit with the single-venue general market equilibrium that dominates macro thinking in the academy.
The intuitive location for the Two-Venue Theorem’s nonmarket class of equilibrium exchange is the complex, highly specialized workplace. Big bureaucratic firms are broadly understood to pay close attention to nonmarket factors in their wage policymaking. Employers learned early in the past century that, in circumstances of imperfect contracting and supervision, labor prices embody information that influences workplace, distinct from marketplace, incentives.
Workplace knowledge, in vast amounts, has accumulated since “Speedy” Taylor’s (1911) time-and-motion studies and the famous 1924-32 Hawthorne experiments conducted at a Chicago factory. The subsequent literature provides a well-documented, practical description of intra-establishment behavior and practices that conflict fundamentally with the single-venue general-market-equilibrium modeling of the macro mainstream. Modern theorists’ stubborn belief that labor pricing and use can be adequately understood as a wholly market phenomena reflects a collective hubris that has deeply damaged their stabilization relevance.
Blog Type: New Keynesians
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