Wage rigidity and the importance of checking your model assumptions

23 Jun, 2014 at 10:20 | Posted in Economics | Comments Off on Wage rigidity and the importance of checking your model assumptions

bewleyThe task of this book is to explain wage rigidities … It seems reasonable to hope that a successful explanation of wage rigidity would contribute to understanding the extent of the welfare loss associated with unemployment and what can be done to reduce it … Many theories of wage rigidity and unemployment include partial answers to these questions as part of their assumptions, so that the phenomena of real interest … are described in the theories’ assumptions. For instance, Lucas concludes that increased unemployment during recessions implies little welfare loss … Lucas’s policy conclusions are not strongly supported … Good support can come only from information that distinguishes his microeconomic assumptions from others yielding different policy recommendations.

A fanciful example may illustrate the danger of taking too narrow a view of instrumentalism. You are an explorer seeking contact with the Dafs, an isolated tribe about which almost nothing is known. You observe one of their villages through binoculars from far away … yellowhatYou observe that every morning on sunny days, men wearing bright yellow hats stand in the backyards and make sweeping gestures toward the sky … When you finally arrange a meeting with some Dafs, you meet a few men with yellow hats and a few other plainer people. Believing the first to be leaders, you offer them presents, at which point all the Dafs are outraged and assault you. What you have not observed is that yellow hats mark slaves, who throw grain to the household chickens in the yard on sunny days and inside on rainy ones … It would have been worth your while not to settle for treating arm waving and wearing yellow hats as the phenomena to be explained, but to test your assumptions about behavior by taking risks to sneak up closer and see precisely what the men were up to.

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