On Persistent Demand Shortages: A Behavioural Approach

Abstract

We incorporate two sets of behavioural assumptions, fairness concerns and insatiable desire for money, into a dynamic optimization model to illuminate how they can generate persistent aggregate demand shortages. We obtain the conditions for persistent unemployment and temporary unemployment. Policy implications differ significantly between the two cases. A monetary expansion raises private consumption under temporary unemployment but not under persistent unemployment. A fiscal expansion may or may not increase short‐run private consumption but crowds out long‐run consumption under temporary unemployment. Under persistent unemployment, however, a fiscal expansion always increases private consumption. The “paradoxes of toil and flexibility” also appear.

Macroeconomic Interdependence Between a Stagnant and a Fully Employed Country

“…However, it cannot treat long‐run shortages of aggregate demand because the length of each period is exogenously given, and aggregate demand shortages appear only in the period in which an exogenous shock occurs. In contrast, Ono and Ishida () propose a dynamic extension of the fair wage model by Akerlof () and Akerlof and Yellen (), which can deal with unemployment as well as full employment during the adjustment process and in the steady state. Therefore, it is adopted here.…”

International Economic Interdependence and Exchange-rate Adjustment under Persistent Stagnation

“…Thus, the possibility of unemployment in the steady state is intrinsically eliminated. To allow for the possibility of persistent unemployment this paper adopts the wage adjustment presented by Ono and Ishida () and assumes that W and W * are sluggish in the presence of unemployment: where wage adjustment speeds α and α * may differ internationally . From Equation , such wage adjustments yield Because P 1 = p 1 ((1 + t ) ω ) P and , from the above equations and the third property of Equation , one finds π and π * to be …”

“…Ono and Ishida () find that 1/ α is the average duration of employment because wage adjustments are due to alternation of incumbent workers, whose fair wages depend on their own past wages and their rivals' wages, with new recruits who have no preconceptions about fair wages.…”

Aggregate demand deficiency, labor unions, and long‐run stagnation

“…However, they deal with a short‐run slump, whereas I focus on long‐run stagnation. Ono and Ishida () and Murota () provide microfoundations for nominal wage stickiness and analyze long‐run stagnation. However, they neither consider the presence of labor unions nor investigate the effects of unemployment benefits .…”

“… Eggertsson and Krugman () explain ‘paradox of thrift,’ ‘paradox of toil,’ and ‘paradox of flexibility.’ See also Eggertsson () for the paradox of toil and Ono and Ishida () for these paradoxes in long‐run stagnation. …”