Beginning with the work of Robert Lucas and Leonard Rapping in 1969, macroeconomists have modeled the labor market as if the wage always adjusts to equate the demand and supply of labor.
I don't think thats a very good approach. It's time to drop the assumption that the demand equals the supply of labor.
I don't think thats a very good approach. It's time to drop the assumption that the demand equals the supply of labor.
Why would you want to delete the labor market clearing equation from an otherwise standard model? Because setting the demand equal to the supply of labor is a terrible way of understanding business cycles.
Hours spent in employment varies over time for three reasons.
First, people enter or leave the labor force. Second, some people lose jobs and others find jobs. Third, people work longer or shorter hours. Most economists confound all three reasons by using only one data series; hours spent in paid employment. That's not a good idea.
Here's data on participation in blue on the right axis against unemployment in red on the left axis. The grey areas are recessions. Participation is smooth; it trends up until 2000 and then trends down. All the action during recessions is in the unemployment rate.
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| Participation and Unemployment |
Perhaps its variation in hours that explains demand and supply variations? Nope. Here is data on average weekly hours (in blue on the right scale) and the same series on unemployment for comparison.
Hours and Unemployment
Why is this a big deal? Because 90% of the macro seminars I attend, at conferences and universities around the world, still assume that the labor market is an auction where anyone can work as many hours as they want at the going wage. Why do we let our students keep doing this?