Core Macroeconomics, Hilary Term 2017

Week 2: Unemployment; New Keynesian economics

The lectures this week introduce "New Keynesian" economics. These models look very much like "new classical" or "real business cycle" models, assuming rational expectations, explicitly theorising dynamic optimisation by consumers and firms, and presuming that markets clear. Where they differ is by making prices sticky, impeding swift adjustment to changes in the the money supply. In a standard, simple New Keynesian model, there is no involuntary unemployment (!): sticky wages and/or prices do not adjust to keep employment at its usual level, but given the real wage, households optimally choose to supply less labour in a recession, rather than wanting to work and being unable to find a job. In tutorials, we will spend less time talking about New Keynesian models and more time investigating unemployment and its determinants.

Assignment

Please write an essay assessing whether economies have natural rates of unemployment, and if so, what their determinants are.

For our tutorial discussion you may also find it useful to have a look at the Department's problems here. You are not required to submit written solutions.

Readings

For the essay, you will find Carlin & Soskice chapters 2 and 15 useful.

A nice survey of empirical work on the determinants of unemployment is Howell, Baker, Glyn, and Schmitt, "Are Protective Labor Market Institutions at the Root of Unemployment? A Critical Review of the Evidence," Capitalism and Society, vol. 2, no. 1 (2007). This can guide you to other studies if you want to pursue the issues in greater depth. Capitalism and Society is available for free download online.

There are a number of useful, accessible articles in the Journal of Economic Perspectives. The Winter 1997 (vol. 11, no. 1) issue has a symposium on the natural rate of unemployment, with articles by a number of prominent scholars. "What we know and do not know about the natural rate of unemployment," by Olivier Blanchard and Lawrence Katz, has an exposition of the competing claims model. The Autumn issue of the same year has a symposium on European unemployment with articles by Nickell and Siebert. In the Winter 2001 (vol. 15, no. 1) issue, Lindbeck & Snower's article "Insiders versus Outsiders" is worth a read. Finally, Ball & Mankiw have a useful article on "The NAIRU in Theory and Practice" in vol. 16, no. 4 (Autumn 2002).

D. Romer's Advanced Macroeconomics, Ch. 9, offers an exposition of several models of equilibrium unemployment. This material is concise and good, but also a bit challenging and technical.

Consider also Roger Farmer's argument that the Natural Rate Hypothesis is "past its sell-by date". A very accessible version of his argument is in his recent book Prosperity for All. He also critiques New Keynesian economics in a way that I find rather persuasive. Because there are few copies of this book around Oxford libraries (though you could buy your own at Blackwell's), I have scanned several chapters which you can download here.
Ch. 3 - "The Demise of the Natural Rate Hypothesis"
Ch. 4 - "Let's Stop Pretending Unemployment if Voluntary"
Ch. 5 - "Five Problems with New Keynesian Economics"
Ch. 6 - "Why Unemployment Persists"

Romer's Advanced Macroeconomics, again, has good material on sticky price New Keynesian models in Ch. 6. It is a bit difficult, though.