20. The classic empirical study supporting monetarist views is Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, N.J.: Princeton University Press for the National Bureau of Economic Research, 1963). See also their Monetary Trends in the United States and the United Kingdom (Chicago: University of Chicago Press for the National Bureau of Economic Research, 1982).
21. See Milton Friedman, “The Role of Monetary Policy,” American Economic Review 58 (1968): 136–49, and Edmund S. Phelps, Microeconomic Foundations of Employment and Inflation Theory (New York: W. W. Norton, 1970). While Friedman’s critique dealt with monetary policy, it was clear that he likewise questioned the efficacy of fiscal policy. The Friedman-Phelps concerns were not new. See, for example, the preface to Ludwig von Mises, The Theory of Money and Credit, new ed. (New Haven, Conn.: Yale University Press, 1953.)
22. An early application of rational expectations was Thomas Sargent and Neil Wallace, “Rational Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule,” Journal of Political Economy 83 (1975): 241–54.
23. In a classic paper, Robert Barro has argued that when the government runs a budget deficit, individuals and businesses regard the deficit as a future tax obligation; to avoid future adverse financial consequences of this obligation, taxpayers increase their current savings out of income. Thus the impact of using deficit rather than tax financing is simply to substitute voluntary saving for involuntary saving (taxation). The interest-rate effects of deficits are zero. See Barro’s “Are Government Bonds Net Wealth?” Journal of Political Economy 82 (1974): 1095–1117. Empirical evidence on Barro’s hypothesis is mixed, although Paul Evans has garnered impressive support. See his “Do Large Deficits Produce High Interest Rates?” American Economic Review 75 (1985): 68–87, or “Do Budget Deficits Raise Nominal Interest Rates? Evidence from Six Countries,” Journal of Monetary Economics 20 (1987): 281–300.
24. It has been suggested that the role of unanticipated inflation in business cycles has recently received less interest by macroeconomic theorists. See N. Gregory Mankiw, “A Quick Refresher Course in Macroeconomics,” Journal of Economic Literature 28 (1990): 1652.
25. For an excellent summary of the New Classical position, see Eric Kades, “New Classical and New Keynesian Models of Business Cycles,” Economic Review, Federal Reserve Bank of Cleveland 4 (1985): 30. The increased leisure argument is used by Lucas and Rapping in their important paper. See Robert E. Lucas, Jr., and Leonard A. Rapping, “Real Wages, Employment, and Inflation,” Journal of Political Economy 77 (1969): 721–54.
26. Franco Modigliani, “The Monetarist Controversy, or Should We Foresake Stabilization Policies?” American Economic Review 67 (1977): 6.
27. See Joseph A. Schumpeter, The Theory of Economic Development (Cambridge, Mass.: Harvard University Press, 1949), chap. 2; John B. Long, Jr. and Charles I. Plosser, “Real Business Cycles,” Journal of Political Economy 91 (1983): 39–69; Edward C. Prescott, “Theory Ahead of Business Cycle Measurement,” Carnegie-Rochester Conference Series on Public Policy 25 (1986): 11–44.
28. Fischer Black, Business Cycles and Equilibrium (New York: Basil Blackwell, 1987.)
29. Stanley Fischer, “Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule,” Journal of Political Economy 85 (1977): 191–205; John B. Taylor, “Aggregate Dynamics and Staggered Contracts,” ibid., 88 (1980): 1–23. For an extended study of modern thinking about labor markets, see Thomas J. Kniesner and Arthur H. Goldsmith, “A Survey of Alternative Models of the Aggregate U.S. Labor Market,” Journal of Economic Literature 25 (1987): 1241–80.
30. Joseph E. Stiglitz, “Theories of Wage Rigidity,” Keynes’ Economic Legacy: Contemporary Economic Theories, ed. James L. Butkiewicz, Kenneth J. Koford, and Jeffrey B. Miller (New York: Praeger, 1986), p. 30. The increased leisure argument is also used by Lucas and Rapping, “Real Wages, Employment and Inflation.” For an older perspective supporting this approach, see, for example, Selig Perlman, A Theory of the Labor Movement (New York, 1928), pp. 212-14.
31. George A. Akerlof and Janet L. Yellen, “A Near-Rational Model of the Business Cycle, with Wage and Price Inertia,” Quarterly Journal of Economics, Supplement, 100 (1985): 823–38; Michael Parkin, “The Output-Inflation Tradeoff When Prices Are Costly to Change,” Journal of Political Economy 94 (1986): 200–224; Laurence Ball, N. Gregory Mankiw, and David Romer, “The New Keynesian Economics and the Output-Inflation Tradeoff,” Brookings Papers on Economic Activity 1 (1988): 1–65. Robert J. Gordon asserts that New Keynesians stress product-market (price)-induced rigidities more than labor-market ones. See his “What Is the New-Keynesian Economics?” Journal of Economic Literature 28 (1990): 1115–71.
32. J. Bradford De Long and Lawrence H. Summers, “Is Increased Price Flexibility Stabilizing?” American Economic Review 76 (1986): 1031–44.
33. The pioneering study is Edmond Malinvaud, The Theory of Unemployment Reconsidered (Oxford: Basil Blackwell, 1977.)
3
The Neoclassical/Austrian Approach: An Overview
In the previous chapter, it was suggested that neoclassical and Austrian economists essentially believed that unemployment varies directly with what was termed “the adjusted real wage.” Increases in the adjusted real wage, other things equal, price some labor out of a job, increasing unemployment. It was further suggested that changes in any of the components of the adjusted real wage could change unemployment. Specifically, unemployment grows with increased money wages, but decreases with increased prices or productivity growth. We now proceed to examine the general validity of this neoclassical/Austrian perspective, and then comment on some general criticisms of the approach. In future chapters, we will analyze more closely the historical experiences that unfolded during the century.
Testing the Basic Model
In its simplest form, the hypothesized model is:
where U stands for the unemployment rate, W for the adjusted real wage (real wages divided by labor productivity), a is a constant term, and b is a coefficient measuring the degree to which unemployment changes with changes in the adjusted real wage.
From information on unemployment and the variables comprising the adjusted real wage, it is possible to perform a statistical evaluation of the neoclassical position. Generally accepted data on the aggregate unemployment rate are available from 1890 to the present.1 Money-wage data are available in abundance, although there is less consensus on which series is appropriate. From 1947, the widely cited official Bureau of Labor Statistics data on money compensation per hour in the business sector are used.2
There is a problem with wage data for the period before 1947. Ideally, wages should be related to a specific period of work effort, so hourly wage data are most desirable. Unfortunately, hourly data are available only for some specific classes of workers, not the economy as a whole. Annual earnings data are available that are much more comprehensive