A New Paradigm for Economic Policy
New Directions in Modern Economics series
Edited by Claude Gnos and Sergio Rossi
Chapter 6: The unemployment issue
Why does full employment not prevail in the economy? Standard Keynesian economics, especially the New Keynesian version of it, concentrates on wage and price rigidities, which allegedly cause unemployment in preventing markets from clearing when demand falls short of supply (see Snowdon and Vane, 2005, pp. 357–432). In so doing, standard Keynesian economics is no doubt at variance with Keynes’s genuine theory of employment. Keynes (1936/1973, p. 27) namely insisted that ‘[t]he essential character of the argument is precisely the same whether or not money-wages, etc., are liable to change’. While standard Keynesians consider that examining why demand may be deficient is not at stake, the important thing being whether or not price and wage flexibility allows supply and demand to counterbalance each other, Keynes (1936/1973) on the contrary focused on demand deficiency per se (see Rotheim, 1998; Gnos, 2003b, 2004a). To grasp the distinction between these approaches, we have to remind ourselves that standard Keynesian economics has been intended to conciliate general equilibrium theory and Keynes’s theory. In this view, Keynes’s theory is a special case of general equilibrium theory, the originality of which is to establish a model in which quantities instead of prices are supposed to counterbalance one another. This view is questionable, though, because it is at odds with Keynes’s fundamental vision of the economy, which he called a ‘wage’ or ‘entrepreneur’ economy. According to Keynes (1936/1973), employment is not determined by the interplay of supply and demand in markets, but unilaterally by entrepreneurs, who make a decision with reference to the demand they are expecting for their output. Then Keynes does not simply argue that demand may be insufficient to promote full employment, but finds the origin of demand deficiency in the excess of saving over investment.
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