Employment Volatility Revisited

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The most embarrassing puzzle in modern macroeconomics is no secret. Total hours worked vary a lot over the business cycle while wages move hardly at all. Everybody knows that reconciling those two facts overburdens the consensus market-centric DSGE model class. Neither intuition nor the evidence supports the high labor-supply elasticities that mainstream theorists need to coherently explain the employment-volatility puzzle.

Mainstream in a corner. What are macro theorists to do? If their goal is to support established mainstream thinking, researchers must keep tinkering with consensus model mechanics, coming up with adjustments that at least hint at accommodating the troublesome evidence. If the exercise turns out to be a Rube-Goldberg mishmash that fails to explain anything but a bit of the targeted evidence, which can be much better explained by alternative models, the research is recognizably Ptolemaic. The deeply troubling practice of conducting research around the (implicit) goal of supporting mainstream theory at the cost of ignoring more powerful alternatives as well as the relevant evidence has become pervasive in modern macroeconomics.

The literature on the employment-volatility puzzle clearly reflects a lot of tinkering, trying a bunch of gambits that include arbitrary restrictions on the workweek, staggered contracts, sticky information, counter-cyclical work-leisure preferences, counter-cyclical labor bargaining power, bargaining over idiosyncratic human capital, government spending, and home technology. None passes the test of rational behavior and correspondence with relevant evidence.  Model-building was clearly not subject to much quality control.

In making my case that the endless tinkering is essentially Ptolemaic, I shall focus on a single hard fact. Given the nature of the market-centric DSGE model class, mainstream research on employment volatility boils down to attempting to show that the cyclical contractions in employment result from jumps in voluntary quits. A pretty big snag with respect to that approach is everybody knows that employment reductions in recession are almost wholly the result of involuntary job loss. That is the unchallenged, unchallengeable finding of well-designed monthly BLS surveys. That is what the millions of workers laid-off during recessions know happened. That is common knowledge about which there is no dispute outside macroeconomics. Why, then, do mainstream theorists isolate themselves in far left field by continuing to construct Rube-Goldberg models engineered to portray cyclical job separation as voluntary? Why do prominent macroeconomists believe that in recession millions of newly unemployed persons lie about having been laid-off from their jobs? How do such vast conspiracies get organized, over and over again?

There is no explanation for the curious behavior of mainstream scholars other than their research being wholly directed to support the existing consensus model. The evidence be damned. Like early astronomers who persisted in constructing goofy models to keep the earth at the center of the solar system, respected researchers seek to support the mainstream model class at the cost both of ignoring the most important evidence and of not developing obviously more powerful alternative models. I do not intend a blanket condemnation of modern macroeconomists. There may be many who reject Ptolemaic objectives in their own analyses of the employment-volatility puzzle. However, given that mainstream gatekeepers in the academy typically reject research outside the coherent market-centric DSGE model framework, it is difficult to get a handle on the population of the free thinkers.

What to do. There is a fundamental economic principle that gets lost in the overriding commitment of mainstream theorists to consensus modeling. If relevant price flexibility is restricted, market adjustments will manifest themselves in quantity movements. Puzzling over the employment volatility that accompanies remarkably stable labor pricing should at some point return the possibility of some sort wage rigidity. Other evidence, notably the central role of involuntary job loss in employment cyclicality and the causal role of nominal demand disturbances in business-cycle mechanics, suggests that the candidate wage rigidity should be both  meaningful (i.e., capable of suppressing wage recontracting) and nominal. If such meaningful wage rigidity (MWR) can be microfounded, we can happily move on from the stabilization-useless applications of search/match/bargaining apparatus that have been piling up in the literature in the attempt to defend coherent market-centric DSGE modeling.

The GEM Project has derived MWR from axiomatic model primitives in the context of price-mediated exchange organized by continuous general decision-rule equilibrium. The Project is able to microfound MWR via the simple expedient of dropping the most arbitrary, indefensible assumption in mainstream economic theory, i.e. restricting rational price-mediated exchange to the marketplace. Once optimizing exchange is generalized to the large, highly-specialized workplace, inherently characterized by costly, asymmetric information and routinized jobs, deriving continuous-equilibrium MWR and explaining the employment-volatility puzzle become straightforward exercises.

Blog Type: Wonkish San Miguel de Allende, Mexico


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