303
See also: Depressions and unemployment 154–61 ■ The Keynesian multiplier
164 – 65 ■ Rational expectations 244–47 ■ Incentives and wages 302K
eynesian economics
(pp.154–61) assumes that
wages in money terms
tend not to fall: they are “sticky”
and respond only slowly to
changing market conditions. When
a recession hits and prices fall,
the real value of wages therefore
increases. Firms then demand less
labor, and unemployment rises.
The new Keynesian economists,
such as US economist John Taylor,
attempt to explain this stickiness.
In the 1970s the introduction of
rational expectations (pp.244–47)
undermined Keynesian economics.
There could be no persistent
unemployment because wages
would fall and government policies
to boost the economy wouldn’t
work. New Keynesian thinking
showed that even with rational
expectations, unemployment might
linger and government policy could
be effective. This was because
wage stickiness could coexist
with rational individuals.
Taylor and US economist Greg
Mankiw argue that prices may
be sticky due to so-called “menucosts”—the costs of making
changes, such as printing new
price lists. Stickiness can also
be caused by labor contracts, in
which wages are fixed for a time.
Individual behavior and rationality
were absent from early Keynesian
models. The new Keynesian
economists placed their Keynesian
conclusions on some firmer
theoretical foundations. ■CONTEMPORARY ECONOMICS
REAL WAGES
RISE DURING
A RECESSION
STICKY WAGES
IN CONTEXT
FOCUS
The macroeconomy
KEY THINKER
John Taylor (1946– )
BEFORE
1936 John Maynard Keynes
argues that government
intervention can pull
economies out of recessions.
1976 Thomas Sargent and
Neil Wallace argue that
rational expectations make
Keynesian macroeconomic
policies useless.
AFTER
1985 Greg Mankiw suggests
that “menu costs”—the cost
to a firm of making price
changes—may cause
price stickiness.
1990 US economist John
Taylor introduces the “Taylor
rule,” showing that central
banks should run active
monetary policies to stabilize
the economy.
If you were going to turn
to only one economist to
understand the problems
facing the economy, there
is little doubt that the
economist would be
John Maynard Keynes.
Greg Mankiw