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  Robert Barro and His Nobel

  By James Annable | Jan 17, 2020

  In the most important contribution to the fixed-wage general-equilibrium (FWGE) literature, Robert Barro and Herschel Grossman (1971), hereafter B&G, posit nominal wage rigidity in order to investigate the interdependence of rationing in the labor and goods markets. Such analysis must be general; partial-equilibrium labor-market analysis is inherently inadequate to the task. B&G identify several macro regimes, the applicability of each depending on which markets are experiencing excess demand or supply. GEM modeling is most compatible with their Keynesian regime, in which the labor market exhibits excess supply.

  Most interesting about the B&G FWGE story is not that their model is one of the most insightful in the Keynesian literature, although it is. What really catches attention is that the authors publicly disowned the analysis around the same time that their FWGE book was published in 1976. By then, assuming nominal wage rigidity and, therefore, failing to rigorously apply market-centric general equilibrium modeling was becoming a mortal sin. New Classical and emerging RBC theorists insisted that the next stop for the powerful theory be the dustbin.

  That judgement was rendered despite the model meeting the standards for good theory that was featured in last week’s post: “Like any good [theory], it provides an explanation for something that is previously unexplainable. Just as important, it makes predictions that can be tested.” It reveals a great deal about the “cultural revolution” nature of the macro wars that B&G agreed that their analysis was not acceptable macroeconomics.

  FWGE modeling and Keynesian consumption. One of the achievements of the GEM Project of which I am most proud is its powerful enrichment and revival the original B&G fixed-wage general-equilibrium model. Generalized rational exchange microfounds their keystone assumption of wage rigidity. B&G used their insightful modeling to explore Clower’s interpretation of the Keynesian consumption function. In their contribution, the primary relation between income and consumer spending is a consequence of Walrasian disequilibrium in the labor market. Worker income, now representing the constrained effective demand for...

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