Cycle and Trend in Models of the Range of Equilibria

Abstract

This paper investigates the potential of models of the range of equilibria to yield a pattern of equilibrium rates of unemployment that is consistent with the observed mix of cycle with no trend in the rate of unemployment. To do this the paper considers a model in which wages are determined by a group of unionised insiders bargaining with an employer. In the model the supply of labour is endogenous. Speci®cations of the utility function are found which are consistent with the mix of cycle and no trend in the rate of unemployment. Of these it is concluded that loss aversion in the evaluation of wage relativities is a crucial ingredient for models of the range of equilibria. I. I n t ro d u c t i o nThis paper investigates the potential of models of the range of macroeconomic equilibria 1 to yield a pattern of equilibrium rates of unemployment that is consistent with the observed mix of cycle with no trend in the rate of unemployment. The presence of a cycle and the absence of a trend are evident in the pattern of rates of unemployment across industrialised economies. 2 In models of the range of equilibria, a cycle in the rate of unemployment can be explained by cyclical movements in the demand for labour. 3 These cyclical movements can be caused by movements in aggregate demand, that is by the Keynesian mechanism. 4 But movements in the demand for labour will also be caused by the trend factors of capital à Financial support was provided by the Australian Research Council. 1 Models of the range of equilibria include models based on customer markets in the selling of goods and services, see Negishi (1979), McDonald (1987, on sectoral spending asymmetries, see Dixon (1988), on loss aversion in wage bargaining, see Bhasker (1990) and on holdout in wage bargaining, see Holden (1997). It has been argued that models of the range of equilibria offer an improved understanding of the relation between in¯ation and unemployment, see McDonald (1995). Lye, McDonald and Sibly (2001) estimate a range of equilibria model for Australia for the period 1967 to 1997. They ®nd that the range model dominates the (nested) unique equilibrium model and that the size of the range is at least 6.8 percentage points of unemployment. 2 Layard, Nickell and Jackman (1991, pp. 1±5) and Lindbeck (1994, especially chapter 2, pp. 8±9) present evidence for cycles but no long run trend. 3 In the Dixon (1988) model movements in the rate of unemployment are caused by changes in the composition of aggregate demand. 4 In the real business cycle literature cyclical movements in labour productivity cause cyclical shifts in the demand for labour.

John Maynard Keynes Meets Milton Friedman and Edmond Phelps: The Range Versus the Natural Rate in Australia, 1965:4 to 2003:3

“… In this paper we compare the estimates of the range model in Lye and McDonald (2005a) with estimates of a natural rate model. We find that the range model is superior to the natural rate model according to econometric criteria and economic plausibility.…”