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Price Flexibility and Full Employment: Barking Up the Wrong (Neoclassical) Tree
Abstract
This article questions the thesis (again in fashion) that, in an advanced economy, price flexibility ensures full employment. (See most standard macro textbooks.) We make the point that explanation of unemployment in terms of price/wage stickiness typified much pre-Keynesian analysis, but not Keynes's theory of involuntary unemployment. Under uncertainty—an essential part of the Keynesian conception—no set of prices consistent with full employment may actually exist: if so, price inflexibility is not the critical obstacle to the attainment of full employment. Finally, with respect to current use of the aggregate demand/aggregate supply (AD/AS) model, we note that once-rejected ideas have returned to the mainstream and that strong arguments against the attribution of necessarily beneficial effects to price and wage flexibility, which ought to be well-known, seem now to be forgotten, Mainstream macroeconomics today is in danger of losing touch with reality.
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References
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