ABSTRACT
The recent empirical literature on the dynamic relationship between real wages and employment was motivated by a class of neoclassical dynamic demand for labour schedules developed by Sargent (1978, 1979). As we derived in Chapter Five above, this analysis generates two testable propositions which have been focused upon in previous investigations. First, real wages ‘cause’ employment in the sense of Granger (1969). Introducing lagged values of real wages into an employment auto-regression should result in a significant reduction in the size of the unexplained variation in employment. Second, no restriction is placed on the extent and direction of the correlation between any particular lagged real wage term and the current employment level. The model does predict, however, that the sum of the coefficients on the lagged real wage terms should be negative. A permanent increase in real wages should eventually result in a permanent reduction in employment.
