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Voluntary or Involuntary Unemployment? Who Cares if we Get the Solution Wrong!

Two of my favorite economists have been going back and forth on the importance of the idea of “involuntary unemployment”. David Andolfatto says that the term adds nothing useful to the conversation. Meanwhile, Roger Farmer says that the term is important because it is the same description Keynes used before the anti-Keynesians made it their mission to discredit Keynesian economics.

Personally, I don’t disagree with the points either of them make. Taxonomy matters, but it’s not a game changer in this case. But here are the key takeaways from both posts:

“The “classical” idea that there is little a government can or should do to help society in a deep recession is nonsense.” (via David)

“The dismissal of ‘involuntary unemployment’ from the lexicon of the modern economist was introduced as part of a deliberate attack on Keynesian economics. It is time to roll back that attack. As I have shown here, ‘involuntary’ unemployment is a useful way of distinguishing unemployment that is part of a social optimum, from unemployment that is not.” (via Roger)

Roger and David would both agree that there’s a place for the government to intervene in the market because economic equilibria are generally suboptimal. The language can bog us down and frankly, I don’t think it matters much whether we use the original Keynesian terminology or stick to David’s view. But the question is, what are we going to do about the unemployment?

This is where things get tricky. Most economists would argue that there’s a problem with prices. Basically, wages are too high or real interest rates are too high. The “wages are too high” argument is basically a supply side argument.  And the “real interest rate is too high” argument is basically a demand side argument. These two views would lead to drastically different policy outcomes. The prior is more inclined to favor cuts in government spending while the latter is more inclined to favor using the central bank to reduce the real interest rate.

But what if both views are wrong? What if there isn’t some price at which the market enters a permanent state of optimal equilibria? Well, if that’s the case then Keynes was right and the government has to be more involved via government spending than most economists would like to admit. It essentially has to act as the spender of last resort. And given how far from a permanent state of optimal equilibria we consistently seem to be I do have to wonder if Keynes didn’t have most of this figured out long ago and we’ve spent too much time being scared about government spending and all the bad stuff that was predicted it would cause (soaring interest rates, hyperinflation, crowding out, etc) to notice that the answer was in front of our faces all along?