More on Sticky Wages

It’s been over four and a half years since I wrote my second most popular post on this blog (“Why are Wages Sticky?”). Although the post was linked to and discussed by Paul Krugman (which is almost always a guarantee of getting a lot of traffic) and by other econoblogosphere standbys like Mark Thoma and Barry Ritholz, unlike most of my other popular posts, it has continued ever since to attract a steady stream of readers. It’s the posts that keep attracting readers long after their original expiration date that I am generally most proud of.

I made a few preliminary points about wage stickiness before getting to my point. First, although Keynes is often supposed to have used sticky wages as the basis for his claim that market forces, unaided by stimulus to aggregate demand, cannot automatically eliminate cyclical unemployment within the short or even medium term, he actually devoted a lot of effort and space in the General Theory to arguing that nominal wage reductions would not increase employment, and to criticizing economists who blamed unemployment on nominal wages fixed by collective bargaining at levels too high to allow all workers to be employed. So, the idea that wage stickiness is a Keynesian explanation for unemployment doesn’t seem to me to be historically accurate.

I also discussed the search theories of unemployment that in some ways have improved our understanding of why some level of unemployment is a normal phenomenon even when people are able to find jobs fairly easily and why search and unemployment can actually be productive, enabling workers and employers to improve the matches between the skills and aptitudes that workers have and the skills and aptitudes that employers are looking for. But search theories also have trouble accounting for some basic facts about unemployment.

First, a lot of job search takes place when workers have jobs while search theories assume that workers can’t or don’t search while they are employed. Second, when unemployment rises in recessions, it’s not because workers mistakenly expect more favorable wage offers than employers are offering and mistakenly turn down job offers that they later regret not having accepted, which is a very skewed way of interpreting what happens in recessions; it’s because workers are laid off by employers who are cutting back output and idling production lines.

I then suggested the following alternative explanation for wage stickiness:

Consider the incentive to cut price of a firm that can’t sell as much as it wants [to sell] at the current price. The firm is off its supply curve. The firm is a price taker in the sense that, if it charges a higher price than its competitors, it won’t sell anything, losing all its sales to competitors. Would the firm have any incentive to cut its price? Presumably, yes. But let’s think about that incentive. Suppose the firm has a maximum output capacity of one unit, and can produce either zero or one units in any time period. Suppose that demand has gone down, so that the firm is not sure if it will be able to sell the unit of output that it produces (assume also that the firm only produces if it has an order in hand). Would such a firm have an incentive to cut price? Only if it felt that, by doing so, it would increase the probability of getting an order sufficiently to compensate for the reduced profit margin at the lower price. Of course, the firm does not want to set a price higher than its competitors, so it will set a price no higher than the price that it expects its competitors to set.

Now consider a different sort of firm, a firm that can easily expand its output. Faced with the prospect of losing its current sales, this type of firm, unlike the first type, could offer to sell an increased amount at a reduced price. How could it sell an increased amount when demand is falling? By undercutting its competitors. A firm willing to cut its price could, by taking share away from its competitors, actually expand its output despite overall falling demand. That is the essence of competitive rivalry. Obviously, not every firm could succeed in such a strategy, but some firms, presumably those with a cost advantage, or a willingness to accept a reduced profit margin, could expand, thereby forcing marginal firms out of the market.

Workers seem to me to have the characteristics of type-one firms, while most actual businesses seem to resemble type-two firms. So what I am suggesting is that the inability of workers to take over the jobs of co-workers (the analog of output expansion by a firm) when faced with the prospect of a layoff means that a powerful incentive operating in non-labor markets for price cutting in response to reduced demand is not present in labor markets. A firm faced with the prospect of being terminated by a customer whose demand for the firm’s product has fallen may offer significant concessions to retain the customer’s business, especially if it can, in the process, gain an increased share of the customer’s business. A worker facing the prospect of a layoff cannot offer his employer a similar deal. And requiring a workforce of many workers, the employer cannot generally avoid the morale-damaging effects of a wage cut on his workforce by replacing current workers with another set of workers at a lower wage than the old workers were getting.

I think that what I wrote four years ago is clearly right, identifying an important reason for wage stickiness. But there’s also another reason that I didn’t mention then, but whose importance has since come to appear increasingly significant to me, especially as a result of writing and rewriting my paper “Hayek, Hicks, Radner and three concepts of intertemporal equilibrium.”

If you are unemployed because the demand for your employer’s product has gone down, and your employer, planning to reduce output, is laying off workers no longer needed, how could you, as an individual worker, unconstrained by a union collective-bargaining agreement or by a minimum-wage law, persuade your employer not to lay you off? Could you really keep your job by offering to accept a wage cut — no matter how big? If you are being laid off because your employer is reducing output, would your offer to work at a lower wage cause your employer to keep output unchanged, despite a reduction in demand? If not, how would your offer to take a pay cut help you keep your job? Unless enough workers are willing to accept a big enough wage cut for your employer to find it profitable to maintain current output instead of cutting output, how would your own willingness to accept a wage cut enable you to keep your job?

Now, if all workers were to accept a sufficiently large wage cut, it might make sense for an employer not to carry out a planned reduction in output, but the offer by any single worker to accept a wage cut certainly would not cause the employer to change its output plans. So, if you are making an independent decision whether to offer to accept a wage cut, and other workers are making their own independent decisions about whether to accept a wage cut, would it be rational for you or any of them to accept a wage cut? Whether it would or wouldn’t might depend on what each worker was expecting other workers to do. But certainly given the expectation that other workers are not offering to accept a wage cut, why would it make any sense for any worker to be the one to offer to accept a wage cut? Would offering to accept a wage cut, increase the likelihood that a worker would be one of the lucky ones chosen not to be laid off? Why would offering to accept a wage cut that no one else was offering to accept, make the worker willing to work for less appear more desirable to the employer than the others that wouldn’t accept a wage cut? One reaction by the employer might be: what’s this guy’s problem?

Combining this way of looking at the incentives workers have to offer to accept wage reductions to keep their jobs with my argument in my post of four years ago, I now am inclined to suggest that unemployment as such provides very little incentive for workers and employers to cut wages. Price cutting in periods of excess supply is often driven by aggressive price cutting by suppliers with large unsold inventories. There may be lots of unemployment, but no one is holding a large stock of unemployed workers, and no is in a position to offer low wages to undercut the position of those currently employed at  nominal wages that, arguably, are too high.

That’s not how labor markets operate. Labor markets involve matching individual workers and individual employers more or less one at a time. If nominal wages fall, it’s not because of an overhang of unsold labor flooding the market; it’s because something is changing the expectations of workers and employers about what wage will be offered by employers, and accepted by workers, for a particular kind of work. If the expected wage is too high, not all workers willing to work at that wage will find employment; if it’s too low, employers will not be able to find as many workers as they would like to hire, but the situation will not change until wage expectations change. And the reason that wage expectations change is not because the excess demand for workers causes any immediate pressure for nominal wages to rise.

The further point I would make is that the optimal responses of workers and the optimal responses of their employers to a recessionary reduction in demand, in which the employers, given current input and output prices, are planning to cut output and lay off workers, are mutually interdependent. While it is, I suppose, theoretically possible that if enough workers decided to immediately offer to accept sufficiently large wage cuts, some employers might forego plans to lay off their workers, there are no obvious market signals that would lead to such a response, because such a response would be contingent on a level of coordination between workers and employers and a convergence of expectations about future outcomes that is almost unimaginable.

One can’t simply assume that it is in the independent self-interest of every worker to accept a wage cut as soon as an employer perceives a reduced demand for its product, making the current level of output unprofitable. But unless all, or enough, workers decide to accept a wage cut, the optimal response of the employer is still likely to be to cut output and lay off workers. There is no automatic mechanism by which the market adjusts to demand shocks to achieve the set of mutually consistent optimal decisions that characterizes a full-employment market-clearing equilibrium. Market-clearing equilibrium requires not merely isolated price and wage cuts by individual suppliers of inputs and final outputs, but a convergence of expectations about the prices of inputs and outputs that will be consistent with market clearing. And there is no market mechanism that achieves that convergence of expectations.

So, this brings me back to Keynes and the idea of sticky wages as the key to explaining cyclical fluctuations in output and employment. Keynes writes at the beginning of chapter 19 of the General Theory.

For the classical theory has been accustomed to rest the supposedly self-adjusting character of the economic system on an assumed fluidity of money-wages; and, when there is rigidity, to lay on this rigidity the blame of maladjustment.

A reduction in money-wages is quite capable in certain circumstances of affording a stimulus to output, as the classical theory supposes. My difference from this theory is primarily a difference of analysis. . . .

The generally accept explanation is . . . quite a simple one. It does not depend on roundabout repercussions, such as we shall discuss below. The argument simply is that a reduction in money wages will, cet. par. Stimulate demand by diminishing the price of the finished product, and will therefore increase output, and will therefore increase output and employment up to the point where  the reduction which labour has agreed to accept in its money wages is just offset by the diminishing marginal efficiency of labour as output . . . is increased. . . .

It is from this type of analysis that I fundamentally differ.

[T]his way of thinking is probably reached as follows. In any given industry we have a demand schedule for the product relating the quantities which can be sold to the prices asked; we have a series of supply schedules relating the prices which will be asked for the sale of different quantities. .  . and these schedules between them lead up to a further schedule which, on the assumption that other costs are unchanged . . . gives us the demand schedule for labour in the industry relating the quantity of employment to different levels of wages . . . This conception is then transferred . . . to industry as a whole; and it is supposed, by a parity of reasoning, that we have a demand schedule for labour in industry as a whole relating the quantity of employment to different levels of wages. It is held that it makes no material difference to this argument whether it is in terms of money-wages or of real wages. If we are thinking of real wages, we must, of course, correct for changes in the value of money; but this leaves the general tendency of the argument unchanged, since prices certainly do not change in exact proportion to changes in money wages.

If this is the groundwork of the argument . . ., surely it is fallacious. For the demand schedules for particular industries can only be constructed on some fixed assumption as to the nature of the demand and supply schedules of other industries and as to the amount of aggregate effective demand. It is invalid, therefore, to transfer the argument to industry as a whole unless we also transfer our assumption that the aggregate effective demand is fixed. Yet this assumption amount to an ignoratio elenchi. For whilst no one would wish to deny the proposition that a reduction in money-wages accompanied by the same aggregate demand as before will be associated with an increase in employment, the precise question at issue is whether the reduction in money wages will or will not be accompanied by the same aggregate effective demand as before measured in money, or, at any rate, measured by an aggregate effective demand which is not reduced in full proportion to the reduction in money-wages. . . But if the classical theory is not allowed to extend by analogy its conclusions in respect of a particular industry to industry as a whole, it is wholly unable to answer the question what effect on employment a reduction in money-wages will have. For it has no method of analysis wherewith to tackle the problem. (General Theory, pp. 257-60)

Keynes’s criticism here is entirely correct. But I would restate slightly differently. Standard microeconomic reasoning about preferences, demand, cost and supply is partial-equilbriium analysis. The focus is on how equilibrium in a single market is achieved by the adjustment of the price in a single market to equate the amount demanded in that market with amount supplied in that market.

Supply and demand is a wonderful analytical tool that can illuminate and clarify many economic problems, providing the key to important empirical insights and knowledge. But supply-demand analysis explicitly – but too often without realizing its limiting implications – assumes that other prices and incomes in other markets are held constant. That assumption essentially means that the market – i.e., the demand, cost and supply curves used to represent the behavioral characteristics of the market being analyzed – is small relative to the rest of the economy, so that changes in that single market can be assumed to have a de minimus effect on the equilibrium of all other markets. (The conditions under which such an assumption could be justified are themselves not unproblematic, but I am now assuming that those problems can in fact be assumed away at least in many applications. And a good empirical economist will have a good instinctual sense for when it’s OK to make the assumption and when it’s not OK to make the assumption.)

So, the underlying assumption of microeconomics is that the individual markets under analysis are very small relative to the whole economy. Why? Because if those markets are not small, we can’t assume that the demand curves, cost curves, and supply curves end up where they started. Because a high price in one market may have effects on other markets and those effects will have further repercussions that move the very demand, cost and supply curves that were drawn to represent the market of interest. If the curves themselves are unstable, the ability to predict the final outcome is greatly impaired if not completely compromised.

The working assumption of the bread and butter partial-equilibrium analysis that constitutes econ 101 is that markets have closed borders. And that assumption is not always valid. If markets have open borders so that there is a lot of spillover between and across markets, the markets can only be analyzed in terms of broader systems of simultaneous equations, not the simplified solutions that we like to draw in two-dimensional space corresponding to intersections of stable supply curves with stable supply curves.

What Keynes was saying is that it makes no sense to draw a curve representing the demand of an entire economy for labor or a curve representing the supply of labor of an entire economy, because the underlying assumption of such curves that all other prices are constant cannot possibly be satisfied when you are drawing a demand curve and a supply curve for an input that generates more than half the income earned in an economy.

But the problem is even deeper than just the inability to draw a curve that meaningfully represents the demand of an entire economy for labor. The assumption that you can model a transition from one point on the curve to another point on the curve is simply untenable, because not only is the assumption that other variables are being held constant untenable and self-contradictory, the underlying assumption that you are starting from an equilibrium state is never satisfied when you are trying to analyze a situation of unemployment – at least if you have enough sense not to assume that economy is starting from, and is not always in, a state of general equilibrium.

So, Keynes was certainly correct to reject the naïve transfer of partial equilibrium theorizing from its legitimate field of applicability in analyzing the effects of small parameter changes on outcomes in individual markets – what later came to be known as comparative statics – to macroeconomic theorizing about economy-wide disturbances in which the assumptions underlying the comparative-statics analysis used in microeconomics are clearly not satisfied. That illegitimate transfer of one kind of theorizing to another has come to be known as the demand for microfoundations in macroeconomic models that is the foundational methodological principle of modern macroeconomics.

The principle, as I have been arguing for some time, is illegitimate for a variety of reasons. And one of those reasons is that microeconomics itself is based on the macroeconomic foundational assumption of a pre-existing general equilibrium, in which all plans in the entire economy are, and will remain, perfectly coordinated throughout the analysis of a particular parameter change in a single market. Once you relax the assumption that all, but one, markets are in equilibrium, the discipline imposed by the assumption of the rationality of general equilibrium and comparative statics is shattered, and a different kind of theorizing must be adopted to replace it.

The search for that different kind of theorizing is the challenge that has always faced macroeconomics. Despite heroic attempts to avoid facing that challenge and pretend that macroeconomics can be built as if it were microeconomics, the search for a different kind of theorizing will continue; it must continue. But it would certainly help if more smart and creative people would join in that search.


19 Responses to “More on Sticky Wages”

  1. 1 philipji October 21, 2018 at 12:02 am

    In a recession firms eventually reach a position where reducing prices will not increase the quantity of the goods they sell. Since wages constitute one of the factors determining price it does not make sense to cut wages at that point.

    So wages are sticky not because workers are unwilling to accept lower wages but because the owners of firms do not benefit by cutting wages.


  2. 2 citizencokane October 21, 2018 at 6:51 am

    I don’t see how cutting wages would reduce aggregate demand. Sure, it will reduce aggregate demand in the consumer goods sector (what Marxists call “Department II goods), but cutting wages necessarily means that the employer retains a larger share of the output, so the cut in demand for consumer goods should imply an increase in the demand for that which the employer would spend the money on: either additional means of production (Department I goods), or on luxury goods. Investment and jobs should flow from the consumer goods sector to the other sectors, and there should be no aggregate shortfall in investment, or in jobs unless the Department I and luxury goods sectors are much less labor intensive than the consumer goods sectors.

    Ah, but what if a particular employer doesn’t want to spend the money on either Department I goods or luxury goods, but instead save it? In that case, the money is thrown onto the money market via the banking system, interest rates will fall, the net profit of enterprise (profit left over from financing costs) will rise, and some other employer will use the cheap credit to make purchases of Department I goods to take advantage of this opportunity.

    See this link for additional thought along these lines:


  3. 3 Rob Rawlings October 21, 2018 at 7:35 am

    I thought the first part of the post gave excellent reasons why wages may be sticky.

    However I am less convinced by the arguments in the second half that argue (if I understand them correctly) that in a situation of generalized insufficient demand wage and other price reductions will not address this demand insufficiency. I thought it was generally accepted in mainstream economics that such a reduction in the price level would increase the value of money and this would itself provide the necessary stimulus to demand to bring the economy back into general equilibrium ? While I agree this is not the simple supply and demand mechanism applied at the macro level that Keynes was criticizing it does seem to provide an easy way out of the dilemma and not require the ‘different kind of theorizing’ that you call for.

    Its quite possible I’m missing something here so your clarification would be welcome (maybe I need to read you Hayek paper!).

    (I was having trouble posting so apologize if there are duplicate’s


  4. 4 David Glasner October 21, 2018 at 7:55 pm

    philipji, Your point would make sense if most firms sold a substantial share of their output to their own workers, but I think that’s not the case, so every firm will perceive that paying its workers less, cetirus paribus, increases its own profit.

    citizenokane, I didn’t say that it would reduce aggregate demand, I said that it would change demand, so it’s not even meaningful to draw a demand curve for labor, because the whole point of a demand for any product in doing supply and demand analysis is that you can hold everything else constant and find a solution isolating just one demand curve and one supply curve. A stable demand curve for labor for a whole economy doesn’t exist even as a concept.

    Rob, You’re talking about what used to be called the Pigou Effect, or sometimes the Pigou-Haberler Effect (there was also a third guy who indepedently thought of the argument but I can’t remember who it was right now). Time has not been kind to that argument, and it’s now regarded as a theoretical curiosity. The assumptions under which the argument might be valid are so extreme, the argument is just not worth taking seriously. A few of the arguments that have been raised against the Pigou Effect, but the discussion is far from exhaustive, are mentioned in the wikipedia article on the Pigou Effect.


  5. 5 Nick Rowe October 22, 2018 at 5:10 am

    David: if your story is right, have you proved too much? Would wages be sticky, or would they be stuck permanently?


  6. 6 David Glasner October 22, 2018 at 5:13 am

    Nick, I wouldn’t say stuck, but very inertial. Nothing keeps wages where they are except the expectation that they will stay where they are.


  7. 7 Nick Rowe October 22, 2018 at 9:57 am

    David: so any expectation can be a self-fullfilling forecast? OK, that’s not precisely the same as “stuck”, but I still think you have proved too much. That gives you a continuum of Long Run (real) equilibria, a la Roger Farmer, regardless of the monetary regime.


  8. 8 David Glasner October 22, 2018 at 10:03 am

    Only an equilibrium expectation can be self-fulfilling. I am saying that in a disequilibrium in “the labor market” there are at best weak forces causing the wages to move toward an equilibrium, which is in part because the whole system of prices has to change not just the wage. I don’t think I have proved anything. I am mainly trying to expose bad habits economists have fallen into in their own theorizing.


  9. 9 Nick Rowe October 22, 2018 at 10:29 am

    David: OK, I am with you now.

    I agree with you on the forces being “weak”. (The simplest way to see this, but not the only way, is to compare a monopolistically comptetitive to a perfectly competitive seller. The latter will lose all sales if he doesn’t cut price by one penny when he needs to; the former will only lose a small amount (and lose an even smaller amount of profit).)

    Doesn’t totally solve the problem though, because “weak” is not the same as “slow”. But it helps.


  10. 10 Henry Rech October 27, 2018 at 3:31 pm

    “………a different kind of theorizing must be adopted to replace it.”

    You have essentially argued the case that neoclassical theory/GET is utterly useless as macro theory. Which seems to contradict your post on Hayek and expectations of a few months ago.

    Relative prices is inapplicable to understanding macroeconomics. Macroeconomics is about income and spending. To understand macroeconomics, what causes spending must be understood.

    Keynes had theory that explained spending. A different kind of theorizing might be required – it already exists.


  11. 11 David Glasner October 28, 2018 at 8:58 pm

    Henry, Actually, what I am criticizing here is applying partial-equilibrium theorizing to the analysis of unemployment. The partial equilibrium analysis essentially uses a supply curve of labor and a demand curve for labor to conclude that the solution for unemployment is to reduce the real wage of labor. My point, as, though in slightly different language, is that the analysis of labor market disequilibrium (unemployment) cannot usefully be undertaken in a partial equilibrium framework, but must be carried out in a general-equilibrium framework. I never said that spending was not an important part of the analysis, and it was not only Keynes who encouraged economists to think about what the determinants of spending are. So I think you are unnecessarily trying to catch me in a contradiction, were none exists. My post on Hayek and expectations was an argument for a properly formulated application of general equilibrium reasoning, and this post is a criticism of the unhelpful adoption of partial equilibrium reasoning to a situation that requires a general-equilibrium modeling strategy.


  12. 12 Henry Rech October 29, 2018 at 4:30 am


    Thanks for picking me up on this. You had consistently made the point about partial equilibrium as you say. I guess I was thrown by this part of the relevant sentence:

    “Once you relax the assumption that all, but one, markets are in equilibrium, the discipline imposed by the assumption of the rationality of general equilibrium and comparative statics is shattered….”

    I find it a little confusing with “general equilibrium” and “comparative statics” in the same boat.

    However, if you are arguing that the analysis of the effect a wage reduction on employment should be analysed within a general equilibrium framework, then I would argue that this will not advance the cause. GET assumes that the PPF is independent of the budget constraint (i.e. the level of income). The problem is that if the wage change is general, the income of a large portion of economic agents is also changed. When attempting to apply GET to macroeconomic questions one element of the fallacy of composition comes into play.


  13. 13 David Glasner October 29, 2018 at 8:52 am

    Henry, You’re welcome. General equilibrium and comparative statics are in the same boat because to do comparative statics in a partial equilibrium context, one must assume that everything, except one parameter affecting one market, is in equilibrium. So general equilibrium is the foundation of partial equilibrium analysis. I view general equilibrium — and I know you disagree — as a special case of macroeconomic equilibrium, which is why I have been trying to remind everyone that microeconomics, as conventionally understood and taught, has macrofoundations. So the simplistic assumption that macroeconomics requires microfoundations is — at best — a half-truth.


  14. 14 Egmont Kakarot-Handtke October 29, 2018 at 1:52 pm

    More on economists’ sticky brains
    Comment on David Glasner on ‘More on Sticky Wages’

    Economics is one of the most embarrassing failures in the history of modern science. The biggest blunders are profit theory and employment theory. Keynes saw the defects of employment theory but could not rectify them.#1 Eventually, the analysis got stuck in inconclusive blather about sticky wages.#2, #3, #4

    David Glasner clearly recognizes that standard economics is one big Fallacy of Composition: “Keynes’s criticism here is entirely correct. But I would restate slightly differently. Standard microeconomic reasoning about preferences, demand, cost and supply is partial-equilibrium analysis.” And: “… Keynes was certainly correct to reject the naïve transfer of partial equilibrium theorizing … to macroeconomic theorizing about economy-wide disturbances in which the assumptions underlying the comparative-statics analysis used in microeconomics are clearly not satisfied.”

    Obviously, a paradigm shift is needed: “The search for that different kind of theorizing is the challenge that has always faced macroeconomics. Despite heroic attempts to avoid facing that challenge and pretend that macroeconomics can be built as if it were microeconomics, the search for a different kind of theorizing will continue; it must continue.”

    David Glasner is too late. What escaped his attention is that the paradigm shift from false microfoundations to true macrofoundations is a done deal.#5

    From the axiomatically correct macrofoundations#6 follows the elementary version of the objective-systemic Employment Law as shown on Wikimedia.#7

    From this equation follows inter alia:
    (i) An increase in the expenditure ratio ρE leads to higher employment L (the Greek letter ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates a budget deficit = credit expansion, a ratio ρE less than 1 indicates credit contraction.
    (ii) Increasing investment expenditures I exert a positive influence on employment.
    (iii) An increase in the factor cost ratio ρF=W/PR leads to higher employment.

    The complete employment equation contains in addition profit distribution, the public sector, and foreign trade.

    Item (i) and (ii) cover Keynes’ familiar arguments about aggregate demand. The factor cost ratio ρF as defined in (iii) embodies the macroeconomic price mechanism. The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This is the OPPOSITE of what microfounded economics teaches.

    The macroeconomic price mechanism, which is formally embodied in ρF, tells everyone that downward stickiness of wages has NEVER been the problem but upward stickiness.

    False theory leads to false policy guidance. With their defective microfounded employment theory, economists bear for 140+ years the political responsibility for the social devastation of mass unemployment.#8

    Egmont Kakarot-Handtke

    #1 Keynes saw the problems but did not solve them

    #2 Employment theory as an example of proto-scientific soapbubbling

    #3 Full employment, the Phillips Curve, and the end of Gaganomics

    #4 Go! ― test the Profit and Employment Law

    #5 From false microfoundations to true macrofoundations

    #6 The macrofoundations approach starts with three axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X. For a start it holds X=O.

    #7 Wikimedia, Employment Law

    #8 For details of the big picture see cross-references Employment


  15. 15 Henry Rech October 29, 2018 at 7:35 pm


    I can’t see that microeconomics can ever by useful as a foundation for macroeconomics. Micro assumes demand and supply curves are independent (the level of income is assumed constant). Whereas, in macro one agent’s income is another agent’s expense so demand and supply are not independent. Income is the prime variable.


  16. 16 philipji October 30, 2018 at 4:45 am

    “philipji, Your point would make sense if most firms sold a substantial share of their output to their own workers, but I think that’s not the case, so every firm will perceive that paying its workers less, cetirus paribus, increases its own profit.”

    Reducing wages would increase the firm’s margin but make hardly an impact on its total profit. Total profit depends on scale of production. At the recession point it is impossible to increase production.


  17. 17 David Glasner November 1, 2018 at 12:12 pm

    philipji, Whether a wage reduction would substantially increase a firm’s profit would depend on the share of wages in the total cost of the firm. But I agree with your larger point that in a recession wage cuts and price cuts by any single firm will not cause a big increase in the firm’s output, which is far more dependent on macroeconomic conditions. Just goes to show that partial-equilibrium analysis — aka microfoundations — don’t get you very far in analyzing macroeconomic — aka general equilibrium (or disequilibrium) — phenomena.


  18. 18 Peter Carva December 29, 2018 at 10:48 pm

    We know from the Leontief input output model that when an industry is a critical one and demand falls then a whole host of different supply industries are going to be negatively affected, a situation even made more complicated today due to the way that the supply chain has evolved. Besides that in an highly capitalized industry a fall in labor costs may do nothing to address a fall in demand. When oil prices go up and demand for air travel falters airlines have no option but to cut services and reduce staff levels including by means of resorting to the outsourcing and casualization of even essential in house services, which in a certain way has been the mechanism that private firms and government utilities and instrumentalities have systematically been resorting to in order to destroy union power and keep wages stagnant. In bad times firms do not look for a reduction in nominal wages, instead they look for a reduction in the offering of casual and part-time work plus bonuses and other indirect forms of remuneration. Another aspect of the modern labour market is the issuance of temporary work visas to foreigners and the offshore procurement of services including on-demand delivery of ICT services over the internet.

    I believe that labour costs are more or less fixed costs with the price of labour no longer being determined by its marginal product value. Firms tend to keep a core number of employees supplemented by individuals taken from a labour army which can either expand or contract according to their needs and paying for such labour a fix price set in conformity with social expectations manipulated by employer groups competing only among themselves for key staff. The norm confronting employees nowadays seems to be this: If you don’t like your pay set either at the legal minimum wage or even bellow that then the door is open.


  1. 1 Phillips Curve Musings | Uneasy Money Trackback on July 5, 2019 at 3:28 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

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