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1. See John Maynard Keynes, The General Theory of Employment, Interest and Money (New York: Harcourt Brace, 1936).

2. On the behavior of economists of the late neoclassical era, see William J. Barber, From New Era to New Deal (Cambridge: Cambridge University Press, 1985).

3. This is so in part because of the famous law of diminishing returns. Also, where there is imperfect competition in product markets, firms must lower prices to sell increased output, lowering the dollar revenue received per unit of increased production. Profit maximizing firms will hire workers up to the point where the marginal cost of the labor is equal to the marginal revenue product of the labor.

4. There is some evidence supporting the view that occasionally a backward-bending supply curve exists (the elasticity of labor supply with respect to wages is negative.) For a discussion of labor-supply elasticity that incorporates some empirical results showing negative elasticities, see Mark R. Killingsworth, Labor Supply (Cambridge: Cambridge University Press, 1983).

5. The elasticity of labor supply is usually estimated to be .20 or lower. For a rigorous discussion of the estimation issues, with citations to several studies, see Thomas E. MacCurdy, “Interpreting Empirical Models of Labor Supply in an Intertemporal Framework with Uncertainty,” Longitudinal Analysis of Labor Market Data, ed. James J. Heckman and Burton Singer (Cambridge: Cambridge University Press, 1985), chap. 7.

6. A number of modern economists have empirically observed the relationship posited by the wages hypothesis. For a recent example, see Stephen J. Nickell and James Symons, “The Real Wage-Employment Relationship in the United States,” Journal of Labor Economics 8 (1990): 1–15.

7. See his The Theory of Unemployment (London: Macmillan, 1933); Industrial Fluctuations (London: Macmillan, 1927); and “Wage Policy and Unemployment,” Economic Journal 37 (1927): 355–68. Well-known later papers include “Real and Money Wage Rates in Relation to Unemployment, ibid., 47 (1937): 405–22, and “Money Wages in Relation to Unemployment,” ibid., 48 (1938): 134–48. Other writers espousing similar views include Jacob Viner, Balanced Deflation, Inflation or More Depression (Minneapolis: University of Minnesota Press, 1933), especially pp. 12-13; William H. Beveridge, Causes and Cures of Unemployment (London: Longman, Green and Co., 1930), chap. XVI; Willford I. King, The Causes of Economic Fluctuations (New York: Ronald Press, 1938), chap. 8; and Lionel Robbins, The Great Depression (London: Macmillan, 1934).

8. See Ludwig von Mises, Human Action, 3d rev. ed. (Chicago: Henry Regnery, 1966), pp. 600, 770.

9. See F. A. Hayek, Monetary Theory and the Trade Cycle (New York: Augustus Kelley, 1966). On the Austrian position as it relates to the Great Depression, see Murray Rothbard, America’s Great Depression (Kansas City: Sheed & Ward, 1963.)

10. Chiaki Nishiyama and Kurt R. Leube, eds., The Essence of Hayek (Stanford: Hoover Institution Press, 1984), p. 7. Hayek, however, believes that “we are … unable to demonstrate a statistical correlation between the distortion of relative prices and the volume of unemployment” (ibid.). This volume in fact does provide evidence of such a statistical relationship.

11. See, for example, Richard J. Jensen, “The Causes and Cures of Unemployment in the Great Depression,” Journal of Interdisciplinary History 19 (1989): 553–83, T. J. Hatton, “A Quarterly Model of the Labour Market in Interwar Britain,” Oxford Bulletin of Economics and Statistics 50 (1988): 1–23, and Michael Beenstock and Peter Warburton, “Wages and Unemployment in Interwar Britain,” Explorations in Economic History 23 (1986): 153–72.

12. For further discussion of the natural rate of unemployment, see below, chapter 13.

13. Specifically, in some states able-bodied recipients of public assistance must register with unemployment offices in order to receive welfare benefits. In some cases, these individuals are not truly looking for employment.

14. See John A. Hobson, The Economics of Unemployment (London: George Allen & Unwin, 1922); W. T. Foster and W. Catchings, Profits (Boston: Houghton Mifflin, 1925); Foster and Catchings, Business Without a Buyer (Boston: Houghton Mifflin, 1927); see also C. H. Douglas, Credit-Power and Democracy (London: C. Palmer, 1920).

15. Actually, Say’s contribution was more than simply “supply creates its own demand.” For an extended discussion, see Thomas Sowell, Say’s Law: An Historical Analysis (Princeton, N.J.: Princeton University Press, 1972.)

16. See A. W. Phillips, “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861–1957,” Economica 25 (1958): 283–99. As the title indicates, Phillips’s original paper examined the wage-unemployment relationship. However, the emphasis soon shifted to the price-unemployment relationship. See Paul A. Samuelson and Robert M. Solow, “Analytical Aspects of Anti-Inflation Policy,” American Economic Review 50 (1960): 177–94, and Richard G. Lipsey, “The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1862–1957: A Further Analysis,” Economica 27 (1960): 1–31.

17. An excellent treatment of the classical versus the Keynesian perspective at a moderately rigorous level is found in Richard T. Froyen, Macroeconomics: Theories and Policies (New York; Macmillan, 1990.)

18. See Phillips, “Unemployment and the Rate of Change.”

19. Irving Fisher popularized the “equation of exchange” and other concepts used by quantity theorists. See, for example his “’The Equation of Exchange’ 1896–1910,” American Economic Review 1 (1911): 296–305, for a typical study. The preeminent quantity theorist between Irving Fisher and Milton Friedman was Clark Warburton. See, for example, his “The Volume of Money and the Price Level Between the World Wars,” Journal of Political Economy 53 (1945): 150–63, or “The Misplaced Emphasis in Contemporary Business-Fluctuation Theory,” Journal of Business 19 (1946): 199–220.

20. The classic empirical study supporting monetarist views is Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, N.J.: Princeton University Press for the National Bureau of Economic Research, 1963). See also their Monetary Trends in the United States and the United Kingdom (Chicago: University of Chicago Press for the National Bureau of Economic Research, 1982).

21. See Milton Friedman, “The Role of Monetary Policy,” American Economic Review 58 (1968): 136–49, and Edmund S. Phelps, Microeconomic Foundations of Employment and Inflation Theory (New York: W. W. Norton, 1970). While Friedman’s critique dealt with monetary policy, it was clear that he likewise questioned the efficacy of fiscal policy. The Friedman-Phelps concerns were not new. See, for example, the preface to Ludwig von Mises, The Theory of Money and Credit, new ed. (New Haven, Conn.: Yale University Press, 1953.)

22. An early application of rational expectations was Thomas Sargent and Neil Wallace, “Rational Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule,” Journal of Political Economy 83 (1975): 241–54.

23. In a classic paper, Robert Barro has argued that when the government runs a budget deficit, individuals and businesses regard the deficit as a future tax obligation; to avoid future adverse financial consequences of this obligation, taxpayers increase their current savings out of income. Thus the impact of using deficit rather than tax financing is simply to substitute voluntary saving for involuntary saving (taxation). The interest-rate effects of deficits are zero. See Barro’s “Are Government Bonds Net Wealth?” Journal of Political Economy 82 (1974): 1095–1117. Empirical evidence on Barro’s hypothesis is mixed, although Paul Evans has garnered impressive support. See his “Do Large Deficits Produce High Interest Rates?” American Economic Review 75 (1985): 68–87, or “Do Budget Deficits Raise Nominal Interest Rates? Evidence from Six Countries,” Journal of Monetary Economics 20 (1987): 281–300.

24. It has been suggested that the role of unanticipated inflation in business cycles has recently received less interest by macroeconomic theorists. See N. Gregory Mankiw, “A Quick Refresher Course in Macroeconomics,” Journal of Economic Literature 28 (1990): 1652.

25. For an excellent summary of the New Classical position, see Eric Kades, “New Classical and New Keynesian Models of Business Cycles,” Economic Review, Federal Reserve Bank of Cleveland 4 (1985): 30. The increased leisure argument is used by Lucas and Rapping in their important paper. See Robert E. Lucas, Jr., and Leonard A. Rapping, “Real Wages, Employment, and Inflation,” Journal of Political Economy 77 (1969): 721–54.

26. Franco Modigliani, “The Monetarist Controversy, or Should We Foresake Stabilization Policies?” American Economic Review 67 (1977): 6.

27. See Joseph A. Schumpeter, The Theory of Economic Development (Cambridge, Mass.: Harvard University Press, 1949), chap. 2; John B. Long, Jr. and Charles I. Plosser, “Real Business Cycles,” Journal of Political Economy 91 (1983): 39–69; Edward C. Prescott, “Theory Ahead of Business Cycle Measurement,” Carnegie-Rochester Conference Series on Public Policy 25 (1986): 11–44.

28. Fischer Black, Business Cycles and Equilibrium (New York: Basil Blackwell, 1987.)

29. Stanley Fischer, “Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule,” Journal of Political Economy 85 (1977): 191–205; John B. Taylor, “Aggregate Dynamics and Staggered Contracts,” ibid., 88 (1980): 1–23. For an extended study of modern thinking about labor markets, see Thomas J. Kniesner and Arthur H. Goldsmith, “A Survey of Alternative Models of the Aggregate U.S. Labor Market,” Journal of Economic Literature 25 (1987): 1241–80.

30. Joseph E. Stiglitz, “Theories of Wage Rigidity,” Keynes’ Economic Legacy: Contemporary Economic Theories, ed. James L. Butkiewicz, Kenneth J. Koford, and Jeffrey B. Miller (New York: Praeger, 1986), p. 30. The increased leisure argument is also used by Lucas and Rapping, “Real Wages, Employment and Inflation.” For an older perspective supporting this approach, see, for example, Selig Perlman, A Theory of the Labor Movement (New York, 1928), pp. 212-14.

31. George A. Akerlof and Janet L. Yellen, “A Near-Rational Model of the Business Cycle, with Wage and Price Inertia,” Quarterly Journal of Economics, Supplement, 100 (1985): 823–38; Michael Parkin, “The Output-Inflation Tradeoff When Prices Are Costly to Change,” Journal of Political Economy 94 (1986): 200–224; Laurence Ball, N. Gregory Mankiw, and David Romer, “The New Keynesian Economics and the Output-Inflation Tradeoff,” Brookings Papers on Economic Activity 1 (1988): 1–65. Robert J. Gordon asserts that New Keynesians stress product-market (price)-induced rigidities more than labor-market ones. See his “What Is the New-Keynesian Economics?” Journal of Economic Literature 28 (1990): 1115–71.

32. J. Bradford De Long and Lawrence H. Summers, “Is Increased Price Flexibility Stabilizing?” American Economic Review 76 (1986): 1031–44.

33. The pioneering study is Edmond Malinvaud, The Theory of Unemployment Reconsidered (Oxford: Basil Blackwell, 1977.)