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How unemployment has been considered by mainstream macroeconomic models?

from Maria Alejandra Madi

From the 1950s onwards, the macroeconomic models of the neoclassical synthesis, based a system of simultaneous equations, focused on the interaction between the market for goods and services and the money market in the context of a general equilibrium analysis. According to John Hicks (1904-1989),  in the general case, the capitalist economy is at full employment level of output.  The underlying employment theory is based on the demand and supply of labour in a competitive market. In fact, this neoclassical approach supposes that price adjustment market mechanisms could guarantee full employment.  In same specific cases, however, the general equilibrium implied by the IS-LM model could not necessarily correspond to a full employment level of output. This situation, called unemployment equilibrium, would be the result of market imperfections, such as rigid money wages, interest-inelastic investment demand, income-inelastic money demand, among others.

In the 1960s, mainstream macroeconomic models expanded the analysis of the negative correlation  between  inflation and unemployment. This correlation was  based on the conclusions drawn from an empirical study  -the Philips curve- about the negative relationship between the evolution of the rate of employment and the rate of variation of nominal wages in England at the turn of the 20th century.  The attempt to incorporate the Phillips curve (trade-off between inflation and unemployment) in the analysis of the labour market dynamics turned out to  put emphasis on the role of nominal wages in determining prices, and ultimately, on the demands of workers that put pressure on inflation.  read more 

  1. September 24, 2016 at 2:30 pm

    Unemployment ― the toughest challenge for economics students
    Comment on Maria Alejandra Madi on ‘How unemployment has been considered by mainstream macroeconomic models?’

    Maria Alejandra Madi tells the history of employment theory since the 1950s and recounts the various recommendations given by economists. This is counterproductive. For a heterodox student it goes without saying that orthodox economics is dead. Hence, there is NO need to reiterate false theories, the only topic of interest is the TRUE employment theory. The students of physics nowadays do not waste much time with the study of of the Geo-centric model or other obsolete theories. Students want to learn the true theory.

    With regard to employment theory it is important to note the following:
    ― IS-LM is refuted and as dead as a doornail (2014),
    ― the (bastard) Phillips curve is refuted and as dead as a doornail (2012),
    ― the correct employment theory is already part of the curriculum of Constructive Heterodoxy (2015).*

    In the following a sketch of the formally and empirically correct employment theory is given. A rather elementary version of the objective structural employment equation is shown on Wikimedia:

    From this equation follows inter alia:
    (i) An increase of the expenditure ratio rhoE leads to higher employment (the letter rho stands for ratio). An expenditure ratio rhoE greater than 1 indicates credit expansion, a ratio rhoE less than 1 indicates credit contraction.
    (ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
    (iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

    The complete AND testable employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

    Items (i) and (ii) cover Keynes’s arguments about the role of aggregate demand, which have been commonsensically right but formally defective. More precisely, Keynes’s multiplier is provable false. The factor cost ratio rhoF as defined in (iii) embodies the price mechanism which works very different from what the representative economist falsely assumes. As a matter of fact, overall employment (in the world economy or a closed national economy) INCREASES if the average wage rate W INCREASES relative to average price P and productivity R.

    So, in simple terms, full employment (in any definition) can be achieved by increasing overall demand (expenditure ratio, investment expenditures etc.) or by INCREASING the average wage rate or by a combination of the two.

    Both, the Walrasian and Keynesian approaches have produced misleading policy advice. Unemployment is ultimately the result of theory failure, that is, of the utter scientific incompetence of economists ― more precisely of orthodox AND heterodox economists.

    By again and again recycling theories that have already been refuted, the pedagogy blog is treading water, keeps students away from the cutting edge of research, and ultimately hampers an effective employment policy.

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Desaster. SSRN Working Paper Series, 2130421: 1–19. URL
    Kakarot-Handtke, E. (2014). Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. URL
    Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Employment. SSRN Working Paper Series, 2576867: 1–11. URL

    * See cross-references New curriculum

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