Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.
-
Upload
jada-mothershead -
Category
Documents
-
view
218 -
download
0
Transcript of Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.
![Page 1: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/1.jpg)
Lecture 1: Constructing a theory of equilibrium unemployment
I. A macroeconomic framework
![Page 2: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/2.jpg)
The traditional Keynesian view
• Unemployment is a short-term phenomenon
• It is due to nominal price rigidities, which create an imbalance between aggregate supply and aggregate demand
• Nominal prices eventually adjust downwards as a result of this imbalance
• Therefore, there is no persistent unemployment
![Page 3: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/3.jpg)
We need a theory of positive equilibrium unemployment
• No economy with zero unemployment has ever been observed
• Two routes to generate unemployment:– Built-in real wage rigidity Labor demand <
labor supply– Built-in frictions: people lose their jobs and it
is physically impossible for them to find another one
![Page 4: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/4.jpg)
The simplest model of real wage rigidity:
Labor demand
Labor supply
Wage floor
UnemploymentEmployment L
w/p
![Page 5: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/5.jpg)
What is wrong with this model?
• No micro foundation for the wage floor we see that later
• It is not a macro model: we do not know where labor demand comes from.
• So we have equilibrium unemployment but we do not know its determinants!
• The model is not very useful
![Page 6: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/6.jpg)
One Step Beyond
• Can we do better and embody the wage rigidity in a growth model?
• Let us try to do it!
![Page 7: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/7.jpg)
Let’s try to add a wage rigidity in the Ramsey model
1
1
max
)1(
t
tt
tt
ttt
t
t
tt
ttt
ttt
L
KAr
rC
CdteC
ww
L
KAw
KCYdt
dK
LAKY
![Page 8: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/8.jpg)
In the long-run
• If the wage floor is not binding, the usual Ramsey steady state holds
• If it is binding, then we are in trouble: equilibrium K/L ratio cannot match both the wage floor and the Ramsey condition
• Because capital adjusts, the LR labor demand curve is horizontal
• Unemployment converges to 100 %!
![Page 9: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/9.jpg)
The problem in the labor demand space:
w/p
L
Wage floor
LD, t=1
LD, t=2
LD, t=3
LRLD
![Page 10: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/10.jpg)
The problem in the FPF space
w w
r
![Page 11: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/11.jpg)
The problem in the phase space
K
C
![Page 12: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/12.jpg)
The Spiral:
• The wage floor pins the return to capital
• But this return to capital is too low for consumers to want to accumulate capital in the long-run
• A spiral of dissaving and unemployment follows
• The issue would be similar in an open-economy model with capital mobility
![Page 13: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/13.jpg)
What is wrong with this model?
• As the economy gets poorer, we expect the wage floor to adjust
• One possibility would be to index it on GDP per capita
• Where would such an indexation come from?
• One intuitive mechanism is that the unemployed exert downward wage pressure
![Page 14: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/14.jpg)
Introducing the wage curve:
• It looks like a labor supply curve• But it is not a labor supply curve• The labor supply curve gives us how much
labor people want to supply at a given wage• The wage curve tells us how the
unemployment rate affects the wage that wage setters ask in a non competitive framework
)( tt
t uhp
w
![Page 15: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/15.jpg)
How it works:
SR Labor demand
LR Labor demand
SR UnemploymentSR Employment L
w/p
Wage curve
Labor force
LR Unemployment
![Page 16: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/16.jpg)
Introducting Long-Run TFP growth
g
L
KA
LLhL
KAw
KCYdt
dK
gA
ALAKY
t
tt
tt
ttt
ttt
tttt
1
1
1
1
)()1(
;)(
![Page 17: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/17.jpg)
In the long-run
• K/L must grow at rate g for the Ramsey condition to hold
• This implies that wages must grow at the same rate g
• But then unemployment must trend down to zero
• This has not been observed in the real world
![Page 18: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/18.jpg)
What is wrong with this model?
• As the economy gets richer, we expect people to ask for higher wages, given u
• Why?
• The wage that is bargained for presumably depends on wage aspirations
• Wage aspirations are proportional to GDP per capita
![Page 19: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/19.jpg)
Augmenting the wage curve
• Wage aspirations depend on variables that grow at g in the long run
• For a BGP with constant u to exist, the wage curve must be homogeneous of degree 1 in these variables
,...)),...(,(,...)),...(,(
,..."","/","",""""
,...),...(
),(
11
1
pttptt
i
pttt
ttt
t
XXbuwXXbuw
ALYwYX
XXbb
buhp
w
![Page 20: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/20.jpg)
How it works
w/p
L
LD, t=1
LR natural rate
LRLD1
LRLD2
LRLD3
WC1
WC2
WC3
![Page 21: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/21.jpg)
Primary Determinants of the natural rate:
• These are Shifts factors that affect the position of the wage curve
• They always matter
• They capture the degree of micro and institutional wage rigidity in the economy
![Page 22: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/22.jpg)
Secondary determinants of the natural rate
• Factors that affect the position of the labor demand curve
• How important they are depends on how wage aspirations are defined
• In some cases, they do not matter at all, because wage aspirations move proportionally
![Page 23: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/23.jpg)
Example 1: wage aspiration = labor productivity
1
)1(
)(
)/,(
11
1
u
L
KA
uL
KAw
LAKY
uL
YLYuhw
t
tt
t
tt
tttt
![Page 24: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/24.jpg)
In this example:
• The short-run and long-run natural rates only depend on primary determinants
• This is because wage aspirations are always proportional to the current wage
• This would be a bit more complicated if production function were not Cobb-Douglas!
![Page 25: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/25.jpg)
Example 2: wages aspiration = lagged labor productivity
)1(1
1
1)1(
)(
)/,(
*
1
12
1
1
11
1
1
111
1
11
gu
L
KAwu
w
uL
KA
uL
KAw
LAKY
Lu
YLYuhw
t
tttt
t
tt
tt
tt
tt
tttt
tt
tttt
![Page 26: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/26.jpg)
In this example:
• The short run natural rate depends positively on TFP and the capital stock
• It depends negatively on past wages
• The only secondary determinant for the LR natural rate is the economy’s growth rate
• Why? As growth is faster, current aspirations fall relative to the wage that employers are willing to pay
![Page 27: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/27.jpg)
Example 3: aspirations grow exogenously at rate g
1
0
*
1
01
1
)1()1(
;)(
1
1
g
Au
L
KAw
g
L
KA
eAALAKY
u
ew
t
tt
t
tt
gtttttt
t
gt
t
![Page 28: Lecture 1: Constructing a theory of equilibrium unemployment I. A macroeconomic framework.](https://reader035.fdocuments.in/reader035/viewer/2022062417/551a7843550346761a8b4c60/html5/thumbnails/28.jpg)
In this example:
• Falls in the LR K/L ratio reduce LRLD with no impact on aspirations
• => r and δ increase the LRNR• => g now increases unemployment through a
lower K/L ratio
• A0 reduces u since aspirations do not match the induced increase in labor demand