MAC22 MMT09 Labor

Covers Chapter 9 of Mitchell, Wray Watts MMT textbook

1. Explain the concept of hysteresis in the rate of unemployment, and how this can be used to show that there is no single natural rate of unemployment.

2. Use data/graphs/empirical evidence to show that there is no natural rate and to provide evidence for hysteresis

3. Explain why the EAPC requires that the workers have money illusion but the firms do not, and that the quit rate should be reduced as the nominal wages rise. Show the that empirical evidence is against this idea.

Student answers:

A1: · Hysteresis is a concept which states that history affects the value of a current issue. In economics, hysteresis states that historical rates of unemployment are likely to influence the current and future rates of unemployment. If people are made redundant in a recession, then they may become demotivated and lose on the job training, which makes them less employable. After a period of unemployment, it is harder for them to find work. Also, firms may be more reluctant to take on workers who have been unemployed for a certain period because they have no advance skills as other fresh people have. The Natural Rate of Unemployment is the rate of unemployment when the labor market is in equilibrium. It is unemployment caused by structural factors (e.g. mismatched skills).Natural rate of employment also called as NAIRU and practical examples shows that the rate of NAIRU is unstable and changing with time to time so it’s not possible we will predict the natural unemployment rate on the basis of hysteresis.

This answer misses the main idea. The history determines the rate and affects and changes the rate. If we keep unemployment low, natural rate will be low. If we allow it to become high, natural rate will become high. If we force transition from high NAIRU to low by active policy, then the NAIRU will become lower. This is the effect of hysteresis -- system remembers its past. This means that the policy implications that Chicago School draws from NAIRU are wrong -- Chicago says the if we try to force NAIRU below Natural rate this will only cause inflation and the unemployment will go back to its original initial natural rate. Hysteresis says that this is not so.

In MMT book chapter 11..The Australian treasury and OECD estimates the NAIRU and the unemployment data taken from 1960 to 2015 and the result shows that the NAIRU is unstable and the reason for this is unknown to economists .So when there is no stable rate then how can economist forecast and predict about unemployment on the basis of hysteresis .Again this answer misses the point. The NAIRU itself keeps changing, responding to history. The GRAPHS should be given and used as evidence. So graphs SHOW that hysteresis exists, because NAIRU itself responds to past unemployment levels. Also because of this same fact, the NAIRU is unstable, since the past keeps changing and the NAIRU keeps changing with the history.

According to Friedman, workers usually take adaptive measures it means that they only see what they observe and the firms use real measures mean they estimate about future and then hire people on wages which are more profitable for them. Due to this workers are in money illusion and they think they are getting higher real wage and this illusion is beneficial for the firms. As prices increase the real wage goes down, firm hire more people at that time and people accept job on seeing the nominal wage rate. And the productivity goes increasing and aggregate demand increasing and the inflation is visible to all. Then labor realize that they become fool and their real wage is too low and they prefer leisure over work and start quitting the job and the new people not hire on lower real wage. But empirical evidence shows that this is not happened as people have to maintain their living and family they do not quit the job. This is more or less correct, but not written very clearly. Also the empirical evidence should be given in greater detail using graphs. The QUIT rate is a key piece of information which should be mentioned, since it does not support the EAPC