ABSTRACT
Macroeconomics, despite its reliance on aggregation and generalization, has to keep track of activities in three distinct markets: (1) goods and services, (2) assets, and (3) labor. It is the interaction of these markets that determines the most important variables of economic activity: (1) the unemployment rate, (2) the inflation rate, and (3) the interest rate. Nevertheless, since its beginnings in the throes of the Great Depression of the 1930s, macroeconomic theory has treated analysis of the labor market as a neglected stepchild. The IS-LM model of the macroeconomy, developed by J.R.Hicks (1937) and Alvin Hansen (1953) to popularize the Keynesian innovations and still the workhorse of textbooks in the subject area, is of course restricted to the first two markets. Even though unemployment was then and is now the major reason for stabilization policy, a strategic simplification allowed the focus of attention to shift to aggregate demand for goods and services, with the presumption that the underlying production function of the economy would translate output into jobs. Later, when the Phillips curve made its appearance in the postwar period, it led a separate life from the mainstream model and was only intended to accommodate a discussion of sporadic and relatively short bouts of inflation. Only in the 1970s was the Phillips curve converted to an aggregate-supply relation which could be allowed to interact with aggregate demand and created the IS-LM-AS model. Even here, the supply and demand decisions in the labor market are suppressed and the goal was to achieve “full-employment output,” as opposed to “full employment” itself.
