New Keynesian search/match modeling of labor behavior has occupied mainstream macro thinking for decades – a remarkable achievement for a theory so fundamentally flawed as to border on uselessness with respect to stabilization policymaking. What follows is a compact look at some of its most debilitating problems.
Ignored evidence. The collective weight of evidence that must be ignored in the NK market-centric analysis of labor behavior has devastated its practical relevance. Interrelated omissions include the following:
>The rational existence and nature of involuntary job loss (IJL), which we all know dominates the cyclical behavior of unemployment. NK search/match modeling ignores IJL. The inattention is both destructive and necessary. Significant IJL cannot rationally exist in friction-enhanced general-market-equilibrium modeling and must be pushed aside.
>The rational existence and nature of pure wage rent. PWR, which also cannot exist in market-centric search/match modeling, is a necessary condition for IJL existence and is the principal explanation for unemployment persistence, the high incidence of recalls in cyclical recoveries, the long tenure of employment in a large number of industries, and the crucial rejection of Keynes’ second classical postulate. Search/match theory also ignores the substantial impact of PWR on the recruitment practices of many firms. The “match” part of mainstream labor theory is useless in instability analysis.
>The rational causation from nominal demand disturbances to same-direction, evidence-consistent movement in employment and output. Market-centric search/match (and more generally FGME) theory does not support significant causation and, once again, cannot usefully inform stabilization policymakers.
>The rational existence and nature of substantial human-resource departments in workplaces restricted by costly, asymmetric employer-employee information. Search/match and, more generally, FGME modeling must ignore the rich implications of actual labor management that are carefully documented outside of market-centric economics.
Selective literature. NK theorists typically reduce labor modeling in highly specialized economies to a choice between the search/match and spot-market frameworks. New Keynesians chose to ignore the huge literature on what goes on inside complex workplaces, e.g. efficiency-wage theory and related modeling such as Herbert Simon’s organization theory. NK labor macroeconomists simply ignore previous efforts to model workplaces restricted by costly, asymmetrical information, creating a black hole in mainstream macroeconomics. My own early work (1977, 1980, 1984) in this field is typical, powerfully describing intra-firm labor pricing and use but being relatively quickly pushed aside by its inability (at that time) to make the workplace framework consistent the rational suppression of wage recontracting. Subsequent work by the GEM Project solved that longstanding problem, demonstrating that ignoring the workplace perspective is the root cause of the NK inability to rationally explain crucial macro evidence and adequately support stabilization policymaking.
Blog Type: New Keynesian