ABSTRACT
A common denominator running through the spectrum of modern macroeconomic theory, be it the new classical or old and new Keynesian, is that unemployment can be reduced only if real wages are cut and that relatively high rates of unemployment are a function of relatively high real wage rates. The key philosophical distinction between the new classical and contemporary Keynesian economics is that for the new classicals unemployment is voluntary whereas for the new Keynesians it is largely involuntary. 1 The new-Keynesian theorists, basing themselves on Keynes’ own foundation contribution to the literature, argue that real wages must be cut in the short run (plant size and technology are held constant) for unemployment to fall. This, assuming that aggregate demand increases sufficiently to absorb the output produced by the increased number of employed individuals. A reduction in real wages is a necessary condition for increasing the level of employment and, thereby, reducing the rate of unemployment. This can be done most efficaciously through a mild inflationary process and such cuts would be acceptable to most workers in a world where prices are sticky downwards (Akerlof 2002; Akerlof et al. 1996a, 1996b, 2000; Fortin 2001). Thus, for the new Keynesians, a key explanatory variable to persistent high rates of unemployment and to increasing unemployment rates, is the downward stickiness of real wages.
