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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org

The New Keynesian Approach to Cycle Theory: Nominal and Real Rigidities

by Monica Dobrescu Bucharest University of Economic Studies [email protected]

Abstract. At the heart of the lies the assumption that do not adjust instantly to equilibrate . Under these circumstances, once the synthesis failed, naturally started to investigate whether the imperfect adjustment of prices could be logically inferred from realistic assumptions regarding the microeconomic environment, and subsequent research led to a variety of new non-walrasian theories regarding the functioning of markets. Thus, the non-walrasian analyses of the labour suggested that could perform other functions than to equilibrate and demand. For instance, in models focused on labour contracts, wages are regarded as an „insurance” provided by the employer to the workers, while in efficiency models, wages are determinants of labour . Such models have the ability to account for , but they are not able to explain the failure of the . The paper aims to investigate the theoretical progress achieved during the past 3 decades, to clarify nominal and real rigidities and evaluate their impact on the and finally, to evaluate the theoretical aspects which need further analyses and refinements.

Key words: nominal rigidities, real rigidities, menu costs, efficiency wages, near rationality JEL classification: E30, E31, E32

1 Introduction raises some difficulties, since individuals are ultimately concerned with real prices and During the past 3 decades, New Keynesian variables: , hours of labour, real economists have investigated whether the etc. To them, the various variables imperfect adjustment of prices could be are of no direct relevance in nominal terms, logically inferred from realistic assumptions since they can be modified quite easily and have regarding the microeconomic environment, the very significance that their name suggests. which led to a variety of non-walrasian theories To the extent that nominal rigidities play an regarding the functioning of markets. These important role in determining cyclical analyses of the labour market suggested that behaviour, it means that these rigidities – which wages could perform other functions than to are small at firm or level – are equilibrate labour supply and demand. For capable of triggering a large effect at the instance, in models focused on labour contracts, macroeconomic level. This is the very wages are regarded as an „insurance” provided assumption that contributed to the recent by the employer to the workers, while in theoretical progress – such as the contributions models, wages are determinants of Mankiw (1985) and Akerlof and Yellen of labour productivity. Such models however, (1985)1 – in understanding the microeconomic have the ability to account for unemployment, foundation of the real effects of aggregate but they are not able to explain the failure of the demand perturbations. classical dichotomy.

Any micro foundation for the failure of the 1 classical dichotomy involves the presence of a Mankiw, N.Gregory – “Small Menu Costs and Large Business Cycles: A of nominal imperfection or rigidity; otherwise, any ”, Quarterly Journal of Economics, May 1985, perturbation of purely nominal nature will leave 100, p.529-37 şi George A. Akerlof, Janet L.Yellen, – A the equilibrium unchanged. Perhaps Near Rational Model of the Business Cycle, with Wage surprisingly, this observation immediately and Inertia, Quarterly Journal of Economics, Supplement, 1985, 100:5, p.823-38.

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org

The possibility that small barriers to adjustment bigger the firm’s motivation to reduce the price. might determine a considerable effect of Since the new output level is lower, then the nominal variations on aggregate economic amount of labour and the real wage will be activity depends on firms’ inclination to change lower as well, so the will prices when changes. Let us decrease. In what regards marginal revenue, the consider, for instance, the case where there is a more it falls, the lesser the firm’s motivation to decrease in output at the macroeconomic level. reduce the price. The main factor influencing When demand for a firm’s products decreases – the shift in marginal revenue is demand as a result of the decrease in output – it may : if this variable decreases together choose between two possible options: it can with output, then the shift in marginal revenue either maintain prices unchanged and reduce will be larger and if the elasticity increases, the production, or it may reduce prices so that a shift will be smaller. reduction in output is no longer required. In order to provide a microeconomic foundation for the role of in triggering 2 The failure of the classical dichotomy based cyclical behaviour, it does not suffice to on microeconomic foundations incorporate the hypotheses of imperfect and of barriers to price adjustment This problem can be analyzed in terms of in the `50s-`60s standard approach. The source marginal cost and marginal revenue. When the of difficulties or of barriers lies with the labour economy is in equilibrium, the two variables are market. To the extent that labour supply is equal, but a contraction of aggregate output inelastic and the only divergence from the shifts the demand curve leftwards, which means walrasian framework is the existence of small that demand falls and so does the firm’s barriers to nominal adjustments, then a decrease marginal revenue. If the firm does not reduce in the amount of labour, combined with a the price, the level of output will correspond to decrease in labour will lead to a large reduction the lower demand but, at this level, the marginal in real wages. In this case, marginal cost will revenue exceeds the marginal cost, so the firm decrease sharply during . As a result, will be motivated to reduce the price and firms’ inclination to reduce prices is strong, increase output to the amount that equates the 2 except for the situation where demand elasticity variables. In essence, firms’ inclination to also decreases considerably. Following the reduce prices may be very low – even though same line of reasoning, estimations point out the reduced demand is harmful – because the that in models whose only departure from the potential gains incurred by the price reduction walrasian framework is the imperfect may be very small, even if the shift in demand competition hypothesis, firms’ inclination to is large. In this situation, the reaction of a large change prices in response to demand shifts is number of firms facing such difficulties in stronger than any barriers to price adjustment. adjusting prices can determine very large real In this way, the classical dichotomy failure effects. If the representative firm is not inclined occurs – according to Romer (1990) – either to change the price and there are price because the marginal cost does not decrease adjustment obstacles, aggregate output will enough after an output contraction induced by decrease. If, on the other hand, the motivation aggregate demand, or because the marginal to reduce prices is strong, all firms will reduce revenue decreases too much, or perhaps, a nominal prices, which means that the negative combination of the two. More generally, firms’ demand will only result in the price inclination to change prices can be imagined as decrease. a function depending on two factors: the impact Firms’ motivation to reduce prices in response of the change on the real price which ensures to lower demand is determined by the way the maximization and the cost incurred by the marginal cost and marginal revenue react. In deviation of the real price from its profit- what regards the former, the more it falls, the maximizing level. In order for the inclination to

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org adjustment to be low, one of two conditions important share of the total cost, it makes the must be fulfilled: (i) the profit-maximizing real cost curve move in a countercyclical direction4. price must respond little to aggregate output The third approach focuses on the cyclical changes2 or (ii) considerable deviations from behaviour of demand elasticity on the the profit-maximizing real price must only have market, suggesting various causes of the shifts small costs. In other words – Romer concludes in elasticity in response to shifts in aggregate – a complete model with large real effects of output. For instance, when the level of output is nominal perturbations implies both nominal high, dissemination of information to barriers and real rigidities. consumers may be done more easily. This effect Theoretical contributions have not yet clarified can impart a pro-cyclical evolution to demand the most important real rigidities, but have elasticity – and consequently to the marginal brought forward several potential candidates, revenue curve – thus diminishing firms’ presented below. A first area of research inclination to price adjustment in response to a focuses on the external shift in aggregate demand. induced by large market externalities3. These None of the above directions however, focuses models investigate the hypothesis and on real rigidities on the labour market and still, mechanisms whereby, in periods of intense real rigidities on this market play an essential economic activity, the acquisition of inputs and part in explaining real effects of nominal sale of final outputs is done more easily than in perturbations. As already shown, if labour periods of low activity; the main argument market were walrasian in nature and labour supporting this hypothesis is that during supply were inelastic, then real wages would favourable periods, is more intense as well have a strong pro-cyclical evolution, and the and markets function properly. The effects of rigidities on the other markets (such as those this hypothesis are a decrease in marginal cost mentioned above) should be extremely during expansions and an increase during powerful to counter-balance the adjustment recessions. tendency of prices incurred by this pro-cyclical The second direction of research analyzes evolution. Still, even though analysts debate the market imperfections deriving from the precise evolution of the real wage throughout existence of imperfect information. These the business cycle, there is no definite empirical models assume that asymmetric information evidence to point out a strong pro-cyclical between solicitants and providers of funds only behaviour. This is precisely the reason why the represent a barrier to searching for external fourth direction of research is trying to explain funding, which means that with asymmetric this matter. information, internal financing is less costly Generally speaking, the real wage may not have than external financing. Since firms obtain a pro-cyclical evolution for two reasons: first, higher profits – and thus, more funds for over the short term, labour supply may be internal financing – during booms, it means that relatively inelastic – a fact not confirmed by imperfections tend to impart a empirical evidence however and secondly, due countercyclical evolution to the cost of capital. to certain labour market imperfections, workers And since the cost of capital represents an may not fit on the labour supply curve for at least one part of the business cycle. These models do away with the strong connection between labour supply elasticity and the real wage response to demand shifts, which 2 The degree of „real rigidities” must be high - Laurence implies that the real wage may not have a pro- Ball, - Real Rigidities and the Non- cyclical evolution, even if labour supply is Neutrality of , Review of Economic Studies, April 1990, 57, p.183-203 3 A se vedea de exemplu Peter A.Diamond - Agregate 4 Vezi de exemplu Ben Bernake, – Agency in Search Equilibrium, Journal of Costs, Worth and Business Fluctuations, American , October 1982, 90, p.881-94 Economic Review, March 1989, 79, p.14-31

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org inelastic. Other labour market imperfections – the standard example of a restaurant faced with such as imperfect information or bilateral the cost of printing new menus. But these menu monopoly induced by the heterogeneity of costs are not in a position to account for a series workers and jobs – could have similar of empirical microeconomic observations implications for the movement of the real wage. regarding firms’ price policies. These To the extent that such imperfections make the observations infirm the hypothesis that price real wage respond modestly to demand shifts, adjustment barriers are given by the the costs of then they substantially reduce firms’ inclination printing and displaying new prices. Moreover, to adjust prices when perturbations turn up. the extent of the price change can vary a lot and Moreover, the possible existence of substantial the probability for price changes to be followed real rigidities on the labour market suggests that by a subsequent additional change is the same, the mechanism whereby small barriers to whether the change in question is large or small. nominal adjustment trigger considerable real Finally, the frequency of price changes is low: effects from nominal perturbations could on average, the nominal price is only modified involve the rigidity of nominal wages rather after erodes the real price by 10%. than of nominal prices. If wages show Under these circumstances, only a very large substantial real rigidity, a demand-driven cost of price adjustment could reconciliate these expansion will only result in a small rise in empirical findings with the approach. optimal real wages. As a result, just as small Similar observations can be found in Carlton barriers to nominal price adjustment can lead to (1986) and Cecchetti (1986)5. substantial price rigidity, similarly, small Akerlof and Yellen6 on the other hand, use the barriers to nominal wage adjustment may lead sintagm near rationality to describe barriers to to substantial wage rigidity nominal adjustments, meaning that firms are We shall next concentrate on the small nominal willing to give up small profits. We must barriers to price adjustment, because they play however take into account that a lot of price the central part in models focused on price policies involve small profit losses. The rigidities. In this context, we must observe that question is why, of all these policies, firms the costs incurred by renegotiating contracts, choose those that involve considerable nominal collecting and processing information and rigidities; the observation that nominal rigidities estimating the optimal price, informing only have small costs – is not very helpful in customers and suppliers about price changes etc trying to find an answer to this question. Even do not in themselves represent costs of nominal though the realism of the near rationality price adjustment. The error lying behind this hypothesis is often questioned, still Akerlof and vision: its promoters consider that maintaining Yellen’s model is not without importance: it constant prices is the only way „to do nothing” suggests that obstacles to price adjustment are about prices. Prices can however, be adjusted not necessarily technological in nature. through numerous simple measures – such as But the most promising direction of research is the recurring absolute increase or the indexation based on an observation by Bennett Mc Callum in line with inflation or nominal GNP – which imply neither renegotiations, nor decision- making costs or information costs. In other words, the existence of costs incurred for 5 Vezi Dennis W. Carlton – The Rigidity of Prices, instance by informing customers about nominal , Sept. 1986, 76, p.637-58 si changes is a consequence – and not a cause – of respectiv, Stephen G.Cecchetti – The Frequency of Price the fact that nominal prices are usually left Adjustment: A Study of the Newsstand Prices of unchanged. Magazines, Journal of , aug.1986, 31, N. Gregory Mankiw focuses on the so-called p.255-74 6 George A.Akerlof, Janet L.Yellen - A Near Rational menu costs – which are the technological costs Model of the Business Cycle, with Wage and Price of changing prices – their name is derived from Inertia, Quarterly Journal of Economics, Supplement, 1985, 100:5

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org

(1986)7: since goods are exchanged for money, line with the general and individuals and not other goods, it is easier to express prices no longer pay attention to nominal prices and and wages in monetary units. In other words, is wages. easier to use the exchange intermediary as a In such an approach, these theories focused on measurement unit, thus expressing prices in small nominal obstacles assert that the real nominal – and not real – terms. In this context, effects of a nominal shock are lower in high- the so-called menu costs may indeed be inflation environments – and this implication responsible for the failure of prices to adjust differs from alternative theories. In traditional continuously. Even if we accept this Keynesian theories for instance, the degree of justification, it is rather unlikely – but not is an exogenous factor. In impossible – that these menu costs and the Lucas’s imperfect information theory (1973)9, difficulties involved in the recalculation of the degree of nominal rigidity does not depend prices should generate substantial nominal on the inflation level, but is determined by the rigidity. difference or the discrepancy between aggregate In the situation where prices are normally kept demand shocks on the one hand and one constant, then adjusting a price in response to particular firm’s demand shocks. shifts in aggregate demand – either through As to empirical evidence, Ball, Mankiw and direct price changes, or by adopting an Romer (1988)10 investigate the real effects of indexation mechanism – involves a conscious aggregate demand shifts in different countries decision by the price setter. In this case, barriers and periods, concluding that the New to perfect price flexibility not only include Keynesians’ predictions are confirmed: the real computing difficulties and adjustment costs, but effects of demand shifts are lower in a high- also the need for the price setter to realize the inflation environment. According to Mankiw11, benefits of price adjustment. Moreover, if most the issue of rigidities is closely connected to the firms only rarely adjust their prices, then the micro foundations of ; in this cost born by a firm adopting a different price context, we must clarify how rigidities do occur policy will comprise not only direct costs, but despite the optimizing behaviour of individuals. also the cost of explaining customers what that The most important finding is that despite small policy is and how it operates. The final outcome obstacles to perfect flexibility, the will most likely be that certain costs8, which, in macroeconomic effect is considerable. In a perfectly flexible walrasian framework would addition, this phenomenon is amplified by a lead to changes in real prices, will affect the series of real wage and price rigidities and by nominal price change considerably. This means the lack of coordination of price changes among that nominal rigidities could be stronger and firms. more complicated than in the situation where Last but not least, the success of recent models the only obstacles would be the computing is largely the result of two innovations: the difficulties and the menu costs. hypothesis and the This analysis suggests that the inflation rate integration of price rigidities and wage represents an important determinant of the rigidities. adjustment barriers’ intensity. In inflation is high, then nominal prices are frequently 9 adjusted, political decision-makers become Robert E.Lucas Jr. – Some International Evidence on Output-Inflation Trade-offs, American Economic Review, aware that they have to make adjustments in June 1973, 63, p.326-334 10 Laurence Ball, N.Gregory Mankiw si David Romer – 7 Bennett McCallum – On “Real” and “Sticky-Price” The New and the Output-Inflation Theories of the Business Cycle, Journal of Money, Trade-off, Brookings Papers on Economic Activity, 1988, and Banking, Nov.1986, 18, p.397-414 no.I, p.1-65 8 Costs connected to the collection and processing of 11 N.Gregory Mankiw – Recent Developments in information, to decision-making regarding adjustment, to Macroeconomics: A Very Quick Refresher Course, contract negotiations, to customers’ and/or employers’ Journal of Money, Credit and Banking, Aug 1988, Part.2, prejudice p.4

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org

As already stated earlier in this paper, the their models, the cost of nominal rigidities for failure to account for nominal rigidities economic agents is much lower than the triggered a series of theoretical research macroeconomic effect; but in the absencs of endeavours, which brought forward a potential motivations for price adjustment, agents refuse explanation: the costs incurred by the price to cover these costs. An interesting adjustment process. But economists objected interpretation of this conclusion is provided by that these costs were trivial, insignificant at the Blanchard and Kiyotaki: the macroeconomic macroeconomic level and therefore could not be effects of nominal rigidity differ from the accepted as a foundation for the New Keynesian individual costs faced by economic agents, models. In response, the New Keynesians because the rigidity derives from an aggregate replied that there were obvious sources of wage demand . A firm during a and price rigidities: implicit labour contracts, cause by contraction is efficiency wages, insider-outsider relationships. confronted with a demand fall – where the The problem is that these are real rigidities, demand curve shifts to – and also with a whereas the Keynesian theory is founded on profit fall. The firm would like the demand nominal rigidities. Real rigidities by themselves curve to shift back to the right and to make the do not represent a hindrance to nominal price same revenue, but this is not possible through a flexibility, because the adjustment of nominal price reduction. Adjusting the price is merely proces in response to a nominal shock does not the second best, or the minimal loss in revenue: necessarily imply any change in real prices. The the „gain” of the adjustment is actually the absence of models based on nominal rigidities optimal of losses between would actually reflect the microeconomic diminished sales and diminished prices. At this principle stating that inidviduals are not point, the recession would end if all the firms concerned with nominal variables. The only adjusted their prices. But no firm believes it can exception to the rule are the small costs incurred single-handedly end the recession and by the nominal adjustments. consequently, it may not make the adjustment, Consequently, recent research relies on the even if its costs are much lower than the premise that reducing nominal rigidities is recession costs. costless and tries to clarify how come a New Keynesians also claim that aggregate substantial rigidity turns up at the demand shocks cause large fluctuations in macroeconomic level. Significant contributions output and welfare, which are inefficient and include: Mankiw12, Akerlof and Yellen13, require the stabilization of aggregate demand. Blanchard and Kiyotaki14, Ball and Romer15. Even though most models do not analyze the Based on economic analyses in imperfect effect of demand fluctuations on , Ball competition, Mankiw, Akerlof and Yellen point and Romer (1987) show that small obstacles to out a simple - yet essential – phenomenon nominal adjustment are enough to cause a large which opens new paths for future research: in reduction in wealth and that aggregate demand fluctuations can be much more costly than 16 12 N.Gregory Mankiw – “Small Menu Costs and Large relative price fluctuations . Business Cycles: A Macroeconomic Model of Monopoly”, Quarterly Journal of Economics, May 1985, 3 Nominal versus real rigidities 100, p.529-37 ; 13 Gerorge A Akerlof şi Janet L. Yellen – “A Near Rational Model of the Business Cycle, with Wage and All these models are correct, but not complete, Price Inertia”, Quarterly Journal of Economics, because they cannot account entirely for the Supplement, 1985, 100:5, p.823-38; dimension and persistence of non-neutralities: 14 Olivier Jean Blanchard, – in real economies, nominal rigidities are and the Effects of Aggregate Demand, American Economic Review, vol.77, sept.1987, p.647-666; 16 Laurence Ball, David Romer – Real Rigidities and the 15 Laurence Ball, David Romer – Are Prices Too Sticky?, Non-, Working Paper 2476, NBER, Working Paper 2171, NBER, febr. 1987 dec.1987

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org amplified by other phenomena. On the other A plausible explanation that consolidates New hand, real rigidities in themselves do not Keynesian models – though little explored so represent a barrier to perfect nominal flexibility. far – is that of asymmetrical effects of demand So it is the joint effect of nominal and real shocks, since the models discussed so far rigidities that explains the business cycle involve symmetrical responses of the economy mechanism feasibly. Such phenomena include to rises and falls in aggregate demand. For real wage and real price rigidities, as well as instance, in many of the asymmetrical effects lack of temporal synchronization of price models, a demand decrease leads to a large changes by firms. Thus, Ball and Romer have output decrease, whereas a demand increase improved previous New Keynesian models, usually leads to price increases. Such which were rather unrealistic and inconsistent asymmetries are very promising, as they with empirical evidence. For instance, support the Keynesian belief in the opportunity substantial nominal rigidities can arise from the for demand stabilization combination of a real rigidity on the labour It is not yet clear if Keynesian models can be market and the imperfect competition adapted to generate such asymmetries, and if hypothesis or the menu costs hypothesis. If they can, whether they can be formalized within firms pay efficiency wages – which generate the framework of current research. real wage rigidity – then real wages may be Apart from these models, recent research has above their equilibrium level, in which case a incorporated two new assumptions into existing decrease in labour demand may considerably models: imperfect competition and more reduce , without triggering a large emphasis on price – rather than wage – reduction in the real wage at the same time, rigidities. In what regards imperfect even if labour supply is inelastic. competition, it is largely acknowledged that The real rigidities’ importance is not yet clear in rigid prices are practically incompatible with what regards their sources, amplitude or precise , because economic agents effects. In addition, even the cumulated effect of are not price setters; therefore, it is only on nominal barriers and real rigidities is not imperfect markets – where firms are able to set entirely capable of explaining the amplitude and prices – that we can analyze the issue of persistence of nominal shocks’ effects on real adjustment. Keynesian models in the `70s variables. In all models, these effects are however, incorporated nominal rigidities in eliminated when the price adjustment occurs, walrasian economie, which often generated but this does not happen in real economies. One deformed results and require additional possible explanation is the assumption of hypotheses. Introducing the imperfect unsynchronized price adjustment by firms, competition hypothesis solves a lot of which results in a longer adjustment period for theoretical problems of the existing models the general price level and implies that nominal through a series of advantages: shocks can have large and long effects, even . The level of output is always demand- though individual prices are changed 17 determined frequently . . Expansions lead to an increase in welfare Research focused on the lack of synchronization . Wage rigidities cause unemployment complement those on nominal rigidities arising through a low aggregate demand from menu costs, because for a given frequency . Nominal rigidities have on of price changes, the lack of synchronization aggregate demand slows down the adjustment of the general price . Imperfect competition clarifies the evolution level. of the real wage throughout the business cycle 17 Olivier J. Blanchard – Price Desynchronization and Price Level Inertia, in Rudiger Dornbusch, Mario Finally, the second theoretical innovation H.Simonsen – Inflation, Debt and Indexation, MIT Press, regards the shift of the research focus on the 1983, p.3-24 goods market. Keynes and his follwers focused

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org on the labour market rigidities and studied on aggregate demand, triggered for instance, by nominal wage rigidities primarily. Current shifts in public spending or in ’ research integrates labour market and goods expectations. There are other possible market rigidities, with an emphasis on the latter explanations for the effects of real shocks on and analyzes the combined effects of both demand – for instance Barro’s model of public nominal and real rigidities. This innovation has spending19; but the nominal rigidities at least two advantages: (i) even though assumption is still the most feasible substantial nominal wage rigidities is present in explanation, considering that such explanations modern economis, their real effects are not assume a large elasticity of labour supply. clear; research in the field of implicit contracts In the models we presented, the slow shows that maintaining employment adjustment of prices results in a temporary independent from wages could be beneficial: deviation of output and employment from their firms prefer to choose the level of employment natural level. they deem efficient, rather than move on the Apart from these models, another type of labour demand curve when real wages change, models have emerged recently, founded on the whereas buyers on the goods market operate phenomenon of – which involves along the demand curve, and (ii) the focus on permanent effects of shocks. Such a model is the goods market re-confirms the observation that proposed by Blanchard and Summers that real wages do not have a counter-cyclical (1986)20 – which postulates that the natural rate evolution throughout the business cycle. of unemployment in European countries At the same time, the focus on the goods market changes when the real unemployment rate reconfirms the observation that real wages do changes, so there is no unique level towards not have a countercyclical evolution; as already which the latter tends to return to. If these shown, this failure of traditional Keynesian theories are correct, then the nominal rigidities models can be solved even if nominal rigidities cannot provide a comprehensive explanation of are only present on the goods market. But it is unemployment, because nominal prices adjust much easier to provide a theoretical explanation to shocks eventually. Under these for the evolution of real wages, when wage circumstances, additional explanations are rigidity is combined with price rigidity: in this required, such as the insider-outsider model case, the effect of a shock on real wages constructed by the two authors. Still, it is depends on the relative size of the adjustments – nominal rigidities that maintain the crucial role both of prices, and of salaries. At the end of this in explaining initial impulses of unemployment. presentation we must discuss the importance and feasibility of recent theories. The real 4 Conclusions effects of nominal disturbances depend on a series of barriers – or imperfections – of The models based on nominal rigidities are nominal nature. The only alternative to this correct, but not complete, because they cannot approach is the assumption of imperfect account entirely for the dimension and information regarding the general price level. persistence of non-neutralities: in real And if we reject the short-term monetary economies, nominal rigidities are amplified by neutrality, we cannot possibly explain the other phenomena. On the other hand, real relationship between real and nominal variables rigidities in themselves do not represent a without resorting to nominal rigidities in the barrier to perfect nominal flexibility. Therefore, economy18. Nominal rigidities are also important to explain the effects of real shocks 19 Robert J.Barro – Output Effects of Purchases, Journal of Political Economy, vol.89, dec.1981, p.1086-1121 18 Laurence Ball, N.Gregory Mankiw si David Romer – 20 Olivier J.Blanchard si – Hysteresis The and the Output-Inflation and the European Unemployment Problem, în Stanley Trade-off, Brookings Papers on Economic Activity, 1988, Fischer - ed., NBER Macroeconomics Annual, MIT no.I, p.16-17 Press, 1986, p.15-78

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org economists tried to integrate nominal and real Demand, American Economic Review, vol.77, sept.1987: rigidities, which led to a series of new theories 647-666 on business fluctuations. Blanchard, Olivier J. (1986), Hysteresis and the Last but not least, the success of recent models European Unemployment Problem, Summers, Lawrence is largely the result of two innovations: the and Stanley, Fischer - ed., NBER imperfect competition hypothesis and the Macroeconomics Annual, MIT Press, 1986 integration of price rigidities and wage rigidities Blanchard, Olivier J. (1982), Price Desynchronization and Price Level Inertia, NBER Working Paper no.900, June 1982: 3-24 References Blanchard, Olivier J. (1983), Price Asynchronization and Akerlof, George A. and Yellen, Janet L. (1985), A Near Price Level Inertia, Rudiger Dornbusch, Mario Rational Model of the Business Cycle, with Wage and H.Simonsen – Inflation, Debt and Indexation, MIT Press, Price Inertia, Quarterly Journal of Economics, 1983 Supplement, 100:5: 823-38 Carlton, Dennis W. (1986), The Rigidity of Prices, Ball, Laurence and Romer, David (1987), Are Prices Too American Economic Review, Sept. 1986, no.76 Sticky?, Working Paper 2171, NBER, Febr. 1987 Diamond, Peter A., (1982), Agregate Demand Ball, Laurence and Romer, David, (1990), Real Rigidities Management in Search Equilibrium, Journal of Political and the Non-Neutrality of Money, Review of Economic Economy, October 1982, no.90: 881-94 Studies, April 1990, no.57: 183-203 Lucas, Robert E., Jr. (1980), The Death of Keynesian Ball, Laurence, Mankiw N.Gregory and Romer, Dr – The Economics, Issues and Ideas (winter 1980), University of New Keynesian Economics and the Output-Inflation Chicago Press, p.18-19 Trade-off, Brookings Papers on Economic Activity, 1988, Lucas, Robert E.,Jr. (1973), Some International Evidence no.I: 16-17 on the Output-Inflation Trade-off, American Economic Barro, Robert J. (1976), and the Review, 63(3): 326-334 Role of , Journal of Monetary Mankiw, N.Gregory (1985), Small Menu Costs and Large Economics, vol.2, 1976 Business Cycles: A Macroeconomic Model of Barro, Robert J. (1984) Rational Expectations and Monopoly”, Quarterly Journal of Economics, May 1985, Macroeconomics in 1984, AEA Papers and Proceedings, no.100: 529-37 vol.74, nr.2, May 1984 Mankiw, N.Gregory (1988), Recent Developments in Barro, Robert J. (1987), Macroeconomics, John Wesley Macroeconomics: A Very Quick Refresher Course, & Sons, New York, 1987 Journal of Money, Credit and Banking, Aug 1988, Part.2 Beaud, Michel and Dostaler, Gilles (2000), Gândirea Mankiw, N.Gregory (1989), Real Business Cycles: A economică de după Keynes, Ed. Eurosong&Book, New Keyensian Perspective, Journal of Economic Bucuresti, 2000 Perspectives, vol.3, no.3 Bernake, Ben and Gertler, Mark, (1989), Agency Costs, Mankiw, N.Gregory (1990), A Quick Refresher Course in Net Worth and Business Fluctuations, American Macroeconomics, Journal of Economic Literature, Economic Review, no 79, 1989: 14-31 vol.28, December Blanchard, Olivier J. (2000) What Do We Know About Mankiw, N.Gregory (1991), The Reincarnation of Macroeconomics that Fisher and Wicksell Did Not?, Keynesian Economics, NBER Working Paper no 3885, NBER Working Paper no.7550, febr. 2000 October Blanchard, Olivier Jean and Kiyotaki, Nobuhiro (1987), McCallum, Bennett (1986), On “Real” and “Sticky-Price” Monopolistic Competition and the Effects of Aggregate Theories of the Business Cycle, Journal of Money, Credit and Banking, Nov., 18: 397-414

Reader PhD Monica Dobrescu is an academic member of the Faculty of Economics, Academy of Economic Studies in Bucharest from the year 2000 and also Chancellor of the Faculty of Economics since 2008. She graduated from the Faculty of International Economic Relations, ASE Bucharest in the year 2000. Starting with her PhD thesis Trends in Current Economic Science, the author has been deeply concerned with one of the top research priorities in contemporary economic analysis: the

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International Journal of Economic Practices and Theories, Vol. 2, No. 1, 2012 (January), e-ISSN 2247 – 7225 www.ijept.org construction of solid microeconomic foundations for macroeconomic analysis in the context of business fluctuations, monetary neutrality and the mechanisms triggering business fluctuations. The author has prior relevant experience and a solid scientific background in the following fields of expertise: contemporary economic doctrines, macroeconomic analysis, microeconomic foundations of macroeconomics, business cycle theories and macroeconomic imbalances, , competitiveness. The author has published 5 books as sole author, main author or co-author in renowned national publishing houses and over 20 articles in national and international scientific journals.

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