Price Flexibility and Full Employment : A Common Misconception

Grieve, Roy H (2009) Price Flexibility and Full Employment : A Common Misconception. Discussion paper. University of Strathclyde, Glasgow.

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    Abstract

    This paper highlights and builds upon Michio Morishima’s sadly neglected thesis that multi-market economies should be envisaged, and modelled, as overdetermined systems, in that the number of conditions to be satisfied for equilibrium exceeds the number of unknowns (equilibrium prices and quantities) to be discovered. This understanding undermines the comfortable supposition (underpinning both New Keynesian and New Classical theoretical approaches) that, even when the economy is not in a position of full employment, a potential equilibrium solution does exist which - if not instantly, at least eventually – will be achieved by market forces. In other words, contrary to the conventional view, observed price and wage stickiness should be considered as contributing to macroeconomic stability rather than inhibiting adjustment to full employment equilibrium. A further casualty of the Morishima perspective is the common textbook rationalisation that the Keynes theory applies only in the short run (with sticky prices) while the classical analysis comes into its own (with flexible prices) in the longer term.