RBC and the Lucas-Rapping theory of unemployment

30 Jul, 2014 at 13:07 | Posted in Economics | 2 Comments

unemployed-thumbLucas and Rapping (1969) claim that cyclical increases in unemployment occur when workers quit their jobs because wages or salaries fall below expectations …

According to this explanation, when wages are unusually low, people become unemployed in order to enjoy free time, substituting leisure for income at a time when they lose the least income …

According to the theory, quits into unemployment increase during recessions, whereas historically quits decrease sharply and roughly half of unremployed workers become jobless because they are laid off … During the recession I studied, people were even afraid to change jobs because new ones might prove unstable and lead to unemployment …

If wages and salaries hardly ever fall, the intertemporal substitution theory is widely applicable only if the unemployed prefer jobless leisure to continued employment at their old pay. However, the attitude and circumstances of the unemployed are not consistent with their having made this choice …

In real business cycle theory, unemployment is interpreted as leisure optimally selected by workers, as in the Lucas-Rapping model. It has proved difficult to construct business cycle models consistent with this assumption and with real wage fluctuations as small as they are in reality, relative to fluctuations in employment.

Truman F. Bewley

This is, of course, only what you would expect of New Classical Chicago economists.

But sadly enough this extraterrestial view of unemployment is actually shared by so called New Keynesians, whose microfounded dynamic stochastic general equilibrium models cannot even incorporate such a basic fact of reality as involuntary unemployment!

Of course, working with microfunded representative agent models, this should come as no surprise. If one representative agent is employed, all representative agents are. The kind of unemployment that occurs is voluntary, since it is only adjustments of the hours of work that these optimizing agents make to maximize their utility.

In the basic DSGE models used by most ‘New Keynesians’, the labour market is always cleared – responding to a changing interest rate, expected life time incomes, or real wages, the representative agent maximizes the utility function by varying her labour supply, money holding and consumption over time. Most importantly – if the real wage somehow deviates from its “equilibrium value,” the representative agent adjust her labour supply, so that when the real wage is higher than its “equilibrium value,” labour supply is increased, and when the real wage is below its “equilibrium value,” labour supply is decreased.

In this model world, unemployment is always an optimal choice to changes in the labour market conditions. Hence, unemployment is totally voluntary. To be unemployed is something one optimally chooses to be.

The final court of appeal for macroeconomic models is the real world.

If substantive questions about the real world are being posed, it is the formalistic-mathematical representations utilized to analyze them that have to match reality, not the other way around.

To Keynes this was self-evident. But obviously not so to New Classical and ‘New Keynesian’ economists.


  1. General equilibrium is a methodological assumption that is fundamentally speculative (read philosophical or ideological). It presupposes that social systems closely resemble “natural” (read physical) systems, when they clearly do not owing to the influence of culture and institutions that have both formal and informal aspects. Moreover, there is a great difference between physical and biological systems wrt to complexity, reflexivity, and emergence.

    Heterodox economists, social scientists, legal scholars, and philosophers of science have examined this mystification in conventional economics in depth. It is completely untenable as a scientific explanation of social and economic causality. It is an ideology — a propagandizing ideology that favors some social, political and economic interests over others.

    • Yes indeed Tom,for example, Gunnar Myrdal’s argument against the neoclassical stable equilibrium approach regarded the use of a subjective and non-observable notion, like utility. To derive theoretical interpretations from this notion,
      the neoclassical approach must introduce some assumptions on the behaviour of economic agents, which are a heritage of Bentham’s utilitarian philosophy and which lack scientific foundations:

      “The notion of stable equilibrium is normally a false analogy to choose when constructing a theory to explain the changes in a social system. What is wrong with the stable equilibrium assumption as applied to social reality is the very idea that a social process follows a direction – though it might move towards it in a circuitous way – towards a position which in some sense or other can be described as a state of equilibrium between forces. Behind this idea is another and still more
      basic assumption, namely that a change will regularly call forth a reaction in the
      system in the form of changes which on the whole go in the opposite direction to
      the first change
      The idea I want to expound… in the normal case there is no such a tendency towards automatic self-stabilisation in the social system. The system is by itself not moving towards any sort of balance between forces, but is constantly on the move away from such a situation. In the normal case a change does not call forth countervailing changes but, instead, supporting changes, which move the system in the same direction as the first change but much further. Because of such circular causation as a social process tends to become cumulative and often gather speed at an accelerating rate”
      (M,Myrdal, G. (1957), Economic Theory and Underdeveloped Regions, London:
      University Paperbacks, Methuen. pp. 12–13).

      Yet, in those years, following the contemporary psychological studies, social scientists turned away from the discredited hedonism introduced by Bentham. The work of economists, instead, ‘began trying to escape into innocent-sounding
      terminology in order to establish a realm of “pure economics”’ see (Myrdal, G. (1970), Objectivity in Social Research, London: Duckworth. M p. 88)

      Later on, according to Myrdal (1970, pp. 58–9), there was a proliferation of terminological innovation, which presented general equilibrium and theories in a
      new form, that is through a new analytical language.In spite of this kind of
      escapism, however, this body of neoclassical economic thought still:

      “incorporates one version or another of the old, discredited rationalistic psychology and utilitarian moral philosophy. By implying them – as practical conclusions make
      evident that it does – it becomes unfounded and false” (Myrdal, 1970, p. 59).

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