• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

How well do they account for the experience of unemployment in OECD economies in the past twenty years?

Extracts from this document...


"The NAIRU is an equilibrium rate of unemployment, which depends upon the labour market characteristics of the economy. Unfortunately it appears to change in ways that are unrelated to the structure of the labour market." Explain the natural rate of unemployment and NAIRU concepts of equilibrium unemployment. How well do they account for the experience of unemployment in OECD economies in the past twenty years? Theories about unemployment, it's causes and possible cures differ greatly depending on the set of assumptions adapted.. The classical theory and Strong Say's Law imply that the economy will always be at full employment (voluntary level of unemployment) with a vertical supply curve, where prices and wages are flexible and can respond to changes in supply and demand immediately. For instance, an increase in money supply will have no effect on output and a change in price will be immediately matched by a change in money wages, as the workers care only about their real wages. The model assumes perfect competition, absence of money illusion and price and wage flexibility. Keynes, on the other hand, believed that assuming underemployment and underproduction in the short run, the supply curve is horizontal and changes in the money supply will have no effect on prices but only lead to an increase in employment. Keynes assumed money wage stickiness and money illusion. In both theories there is no trade off between inflation and unemployment, however the empirical observation named Phillips curve suggested that there is a relationship between the two. The aim of this essay is to explain NRU (market clearing rate of unemployment) ...read more.


through the weakening of the position of labour and reducing BRW to PRW. Secondly, NAIRU itself can be shifted to a lower rate of unemployment either through shifts of BRW (down) or PRW (up) curves. There are clear similarities between NAIRU and NRU, as they both have the same Philips curve equation; short-run being indexed by expected inflation and long run being vertical. However, the underlying micro foundations and mechanisms through which inflation is generated are different. In imperfect competition model it is the market power of wage-settlers and price-settlers, which enable them to achieve BRW and PRW. Whereas in Friedman's model conditions p=mc and w/p=mpl must be satisfied and there are not supernormal profits (e.g. can't have monopoly). The initiating factor of inflation in the imperfect competition model is the change in AD level, which shifts the level of employment away form NAIRU, and any change in the level of employment creates a change in the relative bargaining power of the parties. In this model money supply is used to vary AD and keep the level of employment constant. In Friedman's model, the initiating factor is the monetary impulse. Unexpected rise in the price level creates misperception on behalf of the workers, which in the short run enables the supply of labour to rise and additional output demanded to be produced. Friedman's model and NRU does not account that well for the experience of unemployment in OECD economies in the past twenty years because even at moments when inflation was stabilised unemployment was still rising. ...read more.


Galbraith expresses scepticism in the notion of NAIRU by suggesting that because accelerations in inflation in 1970s was led by commodities, especially oil, or by import price devaluation, and not by wage inflation, economists might as well develop general equilibrium theories proposing NAIROP (non-inflation-accelerating rate of oil production). Furthermore, he believes that because of the instability of NAIRU across time and countries, it is even more uncertain as a cencept. Overall, after the discussion of the notions of NRU and NAIRU, it is clear that there is much confusion about the exact means of estimating it and about its determinants. However, the uncertainty around it does not prevent one to draw possible explanations about unemployment. The supply shocks in the 1970s led to rising inflation and rising unemployment, and although inflation was stabilised in the 1980s one needs to explain the persistence of high unemployment. One of the possible explanations is hysteresis, that is unemployment in this period depends on unemployment in the previous, thus is slow to fall. If there are long-term unemployed workers they might be seen as unemployable, as the shorter your duration of unemployment the more willing the firms will be to employ you. Other explanations for OECD countries include that of great union militancy, labour market rigidities (high firing costs etc), insider-outsider effect, generous benefit system, low investment rate etc. Although these explanations might account well for the persistence of unemployment, it seems like economists are trying to come up with different explanations for the persistence of unemployment in Europe in the 1970s rather than using the general theory NAIRU due to its lack of theoretical justification and a unified theory (how it is derived and determined). ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our University Degree Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related University Degree Macroeconomics essays

  1. Discuss the bread industry in Malaysia - growth, revenue and pricing.

    Income of consumers will affect the demand of bread, when consumer's income increased, they tend to purchase more normal price of bread(normal goods) or starts to buy higher price of bread (luxuries good) such as breads from bread boutiques like Bread Story, and King's confectionery.

  2. Explain the concept of Price Elasticity of Demand and discuss its relevance for Business ...

    An initial increase in price of a particular product may not at first respond substantially as it takes time for consumers to both notice and adjust to the price fluctuations. For instance, after the two global oil price shocks in the 1970's where the price quadrupled, the reaction to the increase in oil prices was moderate.

  1. Macroeconomic analysis of Brazil. In the following sections, we give a brief overview ...

    rate Inflation rate targeting: With inflation rate targeting, the Central Bank estimates and makes public a projected or target inflation rate and attempts to steer actual inflation towards the target by controlling the interest rates. Throughout 2003 to 2006, Brazil's Central Bank pursued a tight monetary policy to maintain single

  2. Welfare Economics. In this essay I will be examine the arguments for and ...

    price which people are willing to pay for the level of output. Therefore there is an overproduction (inefficiency) by firm B at this point. This can be represented on the diagram by the area shaded red. Q2 Q1 One way those economists overcome the market failure caused by such an externality is by imposing Pigou taxation.

  1. Discuss the role of government policy in reducing unemployment and inflation

    This indicates that labour force compasses all the potential of the market and firms can?t produce anymore output and there?s no shortage in demand. Price increase from P1-P2 in Fig.1 below as a result of shift on AD1-AD2 shows an inflationary case where market can?t expand itself due to full employment.

  2. Discuss the rationale behind the WS and PS curves

    This will act like a minimum wage by causing the number of job seekers to be larger than the number of workers firms are willing to hire. Collective bargaining causes the unemployment rate to be higher than it otherwise would be.

  1. The purpose of this coursework is to study the characteristics of inflation in the ...

    Hyperinflation - inflation with a very high growth rate of prices when the price increase more than 100% per year. 2. Inflation on the forms of manifestation is open and hidden. Open inflation - inflation is due to the free growth of prices of consumer goods and industrial resources.

  2. "Can financial markets ever be considered to be truly efficient; given that insider trading ...

    particular investor making consecutive abnormal returns, as over time it is suggested that only normal returns/losses are possible. The problem with answering this question is that it?s notoriously difficult to test the efficiency of a market, and in particular the strong form.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work