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Re-examination of Modern Macroeconomics: Market Failure in a Walrasian Economy and Keynes's Unemployment Equilibrium

Eizo Kawai

No e121, Working Papers from Tokyo Center for Economic Research

Abstract: This study reexamines the skepticism toward the prevailing theories of modern macroeconomics based on the observations of a real economy. Two main hypotheses are tested. First, the price mechanism is significantly incomplete in a Walrasian economy and does not function, particularly under deflation, which leads to market failure in such an economy. This completely differs from "the market failure due to the rigidity of wages and prices, menu cost and asymmetry of information, and so on" as stated by new Keynesianism. The crucial cause of market failure in the Walrasian economy is the unavoidable spillover effects between goods and labor markets under disequilibrium. Walrasian price mechanism completely disregards these effects. Considering these effects, the belief of the Walrasian general equilibrium, along with the assumption of flexible wages and prices, does not hold. The scale of real balance effects is the most critical factor in the study results. A static model suffices for these explications. Dynamic stochastic general equilibrium models are unnecessary and unfeasible. Second, Keynes's unemployment equilibrium is realized due to market failure in the Walrasian economy. Therefore, involuntary unemployment is a result of quantitative aspects and not price aspects. In other words, involuntary unemployment is not caused by the rigidity of real wages but by a shortage of labor demand under rigid real wages. This is possible by re-interpreting the Shapiro-Stiglitz efficiency wage model. Finally, demand is a critical factor in both the short run and long run.

Pages: 40 pages
Date: 2018-03
New Economics Papers: this item is included in nep-mac
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