Understanding Involuntary Unemployment

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 Last week’s post mused about how generalized-exchange modeling, had it been available and recognized, would have fundamentally altered Robert Barro’s career. Most significantly, his work with Hershel Grossman on “fixed-wage general-equilibrium” would have been credited with insightfully microfounding Keynesian income-driven consumption. Barro, early in his professional life, would have earned a durable place in dominant EK rational-behavior, stabilization-relevant macro theory.

More generally, Barro would have been able to merge his macro analysis with the GEM Project’s rational-behavior answer to Keynes’s great question about the causes and consequences of involuntary job loss (IJL). That would have been a springboard to powerful contributions to the policy-relevant development of rigorous macroeconomics. This post is about the fundamental questions that lost research could have answered. A supporting theme is that the directional shift provided by generalization of exchange  would have also prevented Robert Lucas’ influential wrong turn toward sharply limiting the reach of economic theory.

The Questions

One of the best supported facts about U.S. recessions is that most of their increased unemployment results from involuntary lost jobs. Demonstrating the continuous equilibrium existence of ILJ is essential to the stabilization-relevant preservation rational-behavior macro modeling and requires robust answers to three questions. First, who are the involuntary job losers? The GEM Project identifies them by an inherently restricted decision problem. They were not offered, in lieu of losing their already rationed jobs, a wage reduction that did not violate their market-opportunity costs.

Second, why don’t job losers quickly accept their best alternative job? The key here is that ILJ inherently involves the rational payment of wage rents. Such rents greatly complicate joblessness by motivating the laid-off workers’ rejection, in plausible circumstances, of best available jobs, In particular, inherently rationed rent-paying jobs, for which job losers are qualified and would accept but cannot obtain, motivate joining the continuous-equilibrium Harris-Todaro unemployment queue. In addition, job losers can rationally remain unemployed during the period of price-discovery needed to correctly calibrate the rent received in their previous employment. That costly information is necessary in the determination of true market-opportunity costs.

Third is the jackpot question. Why doesn’t the employer offer a wage cut that would prevent the forced job loss? The generalized-exchange model class has derived (from axiomatic model primitives) continuous-equilibrium meaningful wage rigidity, featuring cyclical downward nominal rigidity and chronic, variable rents. MWR rationally suppresses LEV wage recontracting. The firm-centric labor pricing satisfies the Barro critique asserting the power of wage recontracting and uniquely microfounds involuntary job loss and unemployment, easily solving the most consequential problem in stabilization-relevant macro analysis.

A Useful Implication

Robert Lucas’s memorable message that the writ of serious research does not extend to Keynes’s central concern is relevant here: “Involuntary unemployment is not a fact or a phenomenon which it is the task of theorists to explain…. It does not appear possible, even in principle, to classify individual unemployed people as either voluntarily or involuntarily unemployed depending on the characteristics of the decision problem they face. One cannot, even conceptually, arrive at a usable definition of full employment as a state in which no involuntary unemployment exists.” (Lucas (1981), p.243) The GEM Project, with its generalized-exchange framework for constrained decision rules that are optimized in specialized economies, easily resolves Lucas’s conundrum, introducing stabilization-relevant involuntary joblessness into rigorous, continuous-equilibrium macroeconomics. The most consequential leader of the insurgency that pushed Early Keynesians out of the macro mainstream can stop trying to convince theorists, most of whom want to be taken seriously by stabilization policymakers, to ignore the existence of involuntary unemployment.

Blog Type: Wonkish Chicago, Illinois

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