is unemployment lower if unions bargain over employment would there be more employment if unions bargained over employment and not only over wages most economists seem to answer yes 1

monetary policy and real wage cyclicality this article points to the potential role of monetary policy in affecting the degree of real wage cyclicality we show that the degree and direction of real wage cyclicality is determined by the interaction of i the returns to scale in production ii the nature of aggregate shocks and iii monetary policy given that production technology is fairly constant in the short run we suggest that variations in the real wage output covariance depend largely on the combination of the latter two identifying well documented monetary policy phases in six major organization for economic co operation and development oecd countries and accounting for both aggregate demand and supply shocks we provide empirical evidence to support our main theoretical claim

real wages over the business cycle some further evidence over the past 50 years economists have been puzzled by the movement of real wages over the business cycle neoclassical and early keynesian theories advanced the view that real wages are countercyclical varying inversely with employment and output over the business cycle 12 13 on the other hand early empirical evidence by dunlop 9 and tarshis 25 suggested that in fact real wages move procyclically the macroeconomic disequilibrium analysis of barro and grossman 3 provided a theoretical explanation for the possibility of procyclical real wages despite this theoretical work numerous recent empirical tests of the movement of real wages over the business cycle have reached no definite conclusions one reason these studies have reached no definite conclusion lies in the fact that they have been performed at the aggregate level 2 they have ignored the possibility that the agesex race composition of the labor force may change considerably over the course of the business cycle but the human capital theory of becker 4 and oi 21 and the more recent implicit contract theory of azariadis 1 and baily 2 predicts that employment shares of different demographic groups will vary over the business cycle consider the consequences of changing employment shares suppose for instance that firms tend to lay off lower skill and or less senior workers during cyclical downturns and retain workers who on the average are higher skilled and or more senior than the workers laid off the result will be that the quality of the workers still employed will rise as a consequence the aggregate real wage which is typically constructed by dividing the aggregate straight time payroll by aggregate straight time manhours will tend to rise even when no real wage growth has in fact occurred per unit of quality adjusted labor to reverse the example during cyclical expansions employment increases may come disproportionately from among lesser skilled less senior workers because employment is becoming more skewed towards lower paid workers the aggregate real wage may show a decline even when no workers have actually

the labour market in an equilibrium business cycle model abstract this paper extends the basic multimarket model of lucas 1973 to explicitly consider the labour market it builds on an important distinction between the product wage entering the decision function of firms and the real wage entering the decision function of workers because of the unobservability of the price level workers make forecasting errors in trying to calculate their real wage despite having rational expectations this gives rise to a phillips curve the major new result of the paper is the demonstration that wages are less variable than prices which offers an equilibrium interpretation of wage stickiness

real wages over the business cycle evidence from panel data one topic on which keynes did not disagree with classical economists was the cyclical behavior of real wages keynes 1936 as well as various classical writers predicted that real wages should move countercyclically quoting the general theory p 17 in general an increase in employment can only occur through the accompaniment of a decline in real wages thus i am not disputing this vital fact which the classical economists have rightly asserted as indefeasible this prediction is based on the premise of competition and a given short run capital stock increases in employment then correspond to more intensive use of capital and through diminishing product lower real wages for this reason evidence by dunlop 1938 and tarshis 1939 that real wages move procyclically was viewed as paradoxical both dunlop and tarshis based their findings on an observed positive correlation between real and money wages which given the procyclical movement of money wages implies a positive correlation between

the response of real wages to unanticipated money growth abstract this paper investigates the response of real wages to unanticipated money growth in the light of equilibrium theories of the business cycle these theories in their main different versions do not deliver a common and unambiguous hypothesis on this issue while some models implu a countercyclical real wage response during monetary cycles others yield the opposite result of a procyclical real wage econometric analysis of annual and quarterly u s data reported in the paper indicates that there is a weak negative real wage response to an unanticipated increase in money growth

disaggregating the effect of the business cycle on the distribution of income this paper disaggregates total household income into a complete set of components and studies the comparative cyclicality of these com ponent to economic growth comparisons of the relative responsiveness to gnp growth of wages hours of work and total labor market income of heads and wives and transfer income sources of households are made across income race sex and age groups this provides a picture of the channels by which economic growth produces income change significant differences in elasticities are found to exist both between different income components and between different population groups for the same component the narrowing income distribution in times of high growth occurs primarily because of large elasticities on head s labor market income among the poor both wages and hours show evidence of cycli cality the labor market earnings of women both wives and household heads is far less responsive to growth cyclicality in transfer income varies enormously between population groups and by type of transfer

current real business cycle theories and aggregate labor market fluctuations hours worked and the return to working are weakly correlated traditionally the ability to account for this fact has been a litmus test for macroeconomic models existing real business cycle models fail this test dramatically we modify prototypical real business cycle models by allowing government consumption shocks to influence labor market dynamics this modification can in principle bring the models into closer conformity with the data our empirical results indicate that it does

real wages employment and the phillips curve a recent study by bils found real wages to be procyclical contradicting previous findings by geary and kennan who found no consistent relationship and neftci who found countercyclical movements in real wages these studies differed in both methodology and sample period in this study we found that real wages were either procyclical or countercyclical depending on the sample period chosen employment changes generated by aggregate supply shocks were associated with procyclical real wage movements while during years dominated by shifts in aggregate demand real wages were highly countercyclical

in search of a stylised fact do real wages exhibit a consistent pattern of cyclical variability the paper surveys the studies on the cyclical behaviour of real wages published from the twenties onwards the traditional simple neoclassical model of the labour market suggests that real wages tend to move countercyclically however from a theoretical viewpoint there are few reasons to expect this behaviour once the simple model is extended to account for imperfect competition uncertainty lagged responses or contracting between firms and workers empirical studies give different answers to the problem the contributions reviewed in the paper are arranged roughly in a chronological order the interwar period the postwar pre econometric studies the econometric work using aggregate data the evidence produced on the basis of longitudinal data the analyses of the shock responsiveness of real wages and finally the most recent papers attempting a reconciliation of the somewhat conflicting evidence derived from aggregate and panel data

a model of involuntary unemployment and wage rigidity worker incentives and the threat of dismissal this paper analyzes a model that highlights imperfect monitoring and the threat of dismissal as microeconomic underpinnings for the efficiency wage hypothesis my major innovation is to allow the rules for dismissal as well as the wage to be determined endogenously as the equilibrium of a stackelberg game played between firms and workers the key results are as follows a nontrivial equilibrium where positive output is produced must involve involuntary unemployment in that employed workers are strictly better off than are the unemployed in addition the equilibrium wage is rigid with respect to exogenous shifts in productivity

sectoral shifts and cyclical unemployment a substantial fraction of cyclical unemployment is better characterized as fluctuations of the frictional or natural rate than as deviations from some relatively stable natural rate shifts of employment demand between sectors of the economy necessitate continuous labor reallocation since it takes time for workers to find new jobs some unemployment is unavoidable this paper presents evidence that most of the unemployment fluctuations of the seventies unlike those in the sixties were induced by unusual structural shifts within the u s economy simple time series models of layoffs and unemployment are constructed that include a measure of structural shifts within the labor market these models are estimated and a derived natural rate series is constructed

business cycles in the united kingdom facts and fictions this paper documents the statistical properties of contemporary business fluctuations in the united kingdom we study the period 1956 90 using quarterly detrended data on key aggregate variables we compute selected moments of the data compare our results with those for the united states and rigorously test for dynamic instabilities our findings confirm the existence of substantive cyclical regularities both across countries and across time some notable cross country differences are also identified conclusions about stability are shown to be potentially sensitive to the method of testing in general cross correlations are appreciably more stable than standard deviations

the effect of implicit contracts on the movement of wages over the business cycle evidence from micro data in this paper we address the question of whether wages are affected by labor market conditions in a manner more consistent with a contract approach than with a standard spot market model from a simple implicit contract model we derive implications about the links between wages and past labor market conditions using individual data from the current population survey and the panel study of income dynamics we find that an implicit contract model with costless mobility describes these links better than either a simple spot market model or an implicit contract model with costly mobility

changes in the cyclical pattern of real wages evidence from nine countries 1955 80 monetary policy in the united kingdom the monetarist vice has gripped the economy even longer and similar deflationary policies have been in effect in other western economies interestingly enough these policies were instituted in the context of a prolonged period of economic decline annual average rates of growth of gross domestic product for nine oecd countries fell from 6 8 to 5 o to 2 6 over the periods i955 66 i966 73 and i973 79 2 similarly unemployment has risen dramatically in the last io years the causes of slow growth and high unemployment are undoubtedly various however it is clear that restrictive macroeconomic policy has played an important role that is the recent situation is at least in part attributable to a deliberate effort to induce an economic slump the task of systematically examining the origins and motivations of this policy still awaits us however this paper presents an account of a general development in the pattern of real wages over the business cycle which is a plausible determinant of current policy the evidence indicates that short run cyclical movements in output no longer exert a determinate influence on real wage growth a development which may have been the impetus for long term deflation this account is based on an econometric study of nine countries over the period i955 80 the study has three noteworthy econometric features the first is that data from the nine countries are combined in a pooled model with homogeneous coefficients the use of a cross national sample ensures against the attribution of general theoretical status to particular empirical findings from a single country 3 second the units of observation are business cycle turning

new evidence on real wage employment correlations from u s manufacturing data abstract the stylized fact of positive real wage employment correlation first noted by dunlop 1938 tarshis 1939 and keynes 1939 is re examined using alternative price deflators and detrending procedures we find little evidence that real wages are uniformly procyclical in either aggregate or disaggregated u s manufacturing

an econometric analysis of fluctuations in aggregate labor supply and demand the paper contains a simple equilibrium model of the labor market the supply function allows for intertemporal substitution in response to real wage fluctuations and the demand function allows for adjustment costs on employment the supply and demand functions both solve quadratic partial adjustment problems driven by rational expectations about future real wages the market equilibrium also solves a partial adjustment problem driven by rational expectations about future preference and technology shocks two related issues are emphasized the identification of dynamic labor supply and demand functions and the theoretical interpretation of serial correlation in employment and real wages when the supply and demand shocks are assumed to be ar 1 processes which are not causally related the model delivers a simple structure for the equilibrium process for employment and real wages which is a restricted var 2 this simple structure facilitates the interpretation of summary statistics on the time series properties of observed employment and real wage series the supply and demand functions can both be locally identified using only employment and real wage data an illustrative application is presented using u s manufacturing data for the period 1948 1971

the anticipated real interest rate capital utilization and the cyclical pattern of real wages abstract this paper develops a channel through which increases in anticipated real interest rates can be expansionary for current aggregate labor demand and current output supply the key feature of the model is the introduction of a user cost of capital utilization which confronts the firm with the intertemporal problem of the optimal choices of capital utilization and depreciation the resulting variation in capital utilization and capital services in response to fluctuations in the real rate of interest shifts the marginal product of labor and thus the demand for labor at the same time and in the same direction that lucas rapping real interest rate effects operate on labor supply the complete model places no a priori restrictions on the cyclical pattern of real wages thus avoiding the countercyclical real wage prediction made by keynes and various classical writers that is rejected by the data estimates of a labor demand schedule for the annual u s data reveal a significantly positive real interest rate effect

a traditional interpretation of macroeconomic fluctuations under the traditional interpretation of macroeconomic fluctuations aggregate demand shocks move output and prices in the same direction while aggregate supply shocks move output and prices in opposite directions this paper examines the joint behavior of u s output unemployment prices wages and nominal money and asks whether it is consistent with this interpretation the answer is a qualified yes

relative prices and the demand for labour in british manufacturing the existence of an aggregate demand for labour schedule derived from profit maximization of the individual firm and giving a negative relationship between the labour capital ratio and the real wage is central to most traditional theoretical macroeconomics even though such a relationship is typically not embodied in macroeconomic models but beginning with the work of dunlop 1938 and tarshis 1939 the negative relationship could not be found in the data a more modern reference is bodkin 1969 this evidence led naturally to disequilibrium analysis notably that of barro and grossman 1971 more recently sargent 1978 has attempted with some success to rehabilitate the demand for labour schedule by showing that costly adjustment of the workforce obscures the current relationship between the wage and labour demand while leaving it essentially intact that paper and the related one by neftci 1978 was criticized by geary and kennan 1979 because it had used retail prices to represent output prices and they showed that for a number of countries employment could not be explained satisfactorily by the real product wage however geary and kennan failed to allow for the simultaneous effect of the real prices of raw materials and capital services in this paper we shall see that allowing for the effects of other relative prices notably the price of inputs relative to output and the real interest rate the real wage has a powerful but slow acting negative effect on the demand for labour the long run elasticity is about 2 and the mean lag is over 18 months we also find that the price of inputs has a long run elasticity of about 2 and that high values of the real interest rate have a powerful depressant effect on the level of employment in manufacturing the most striking implication for policy of our analysis is that measures of demand output money government spending do not have a significant influence on manufacturing employment controlling for the effects of relative prices thus government macroeconomic policy can affect the level of employment in manufacturing if and only if it can affect relative prices

the real wage employment relationship in the united states this article examines the real wage employment relationship in the united states in the light of the diversity of results in the literature it demonstrates that when the relationship is correctly specified in the sense that due allowance is made for technical progress and capital accumulation and the appropriate value added deflator is used for the wage then a negative relationship may be observed in the data an incorrect specification however is as likely to lead to a positive relationship as a negative one

real wages over the business cycle a band spectrum approach this paper presents new evidence on the cyclical relationship between real wages and aggregate employment as is well known models that attribute fluctuations in output to movements in aggregate demand and retain the assumption of flexible product prices the adpf hypothesis imply countercyclical real wage movements as employment adjusts along a downward sloping aggregate demand for labor schedule in contrast real business cycle theories 10 15 13 suggest procyclical movements as workers substitute work for leisure along dynamic labor supply schedules the empirical evidence on these propositions remains mixed some influential studies report a negative relationship 4 5 25 others report a positive relationship 2 12 18 and geary and kennan gk 7 to identify the purely business cycle correlation and distinguish it from correlations at very high and very low frequencies the frequency domain decomposition provides a simple framework for reconciling the conflicting conclusions of previous studies and for focusing attention on the business cycle relationship i show that the highly significant positive or negative correlations reported in previous studies are attributable to variations at frequencies far too high or far too low to be associated with the business cycle the true business cycle relationship is quite different from that revealed by simple regressions of real wages on employment i find a weak but statistically significant negative relationship over business cycle frequencies for the post war u s data when wages are deflated by the producer price index ppi the negative relationship is particularly strong over the subperiod 1947 70 but becomes weak and insignificant over the last sixteen years 1971 86 this finding is consistent with the widely held belief that in the former period cyclical movements in employment were determined by changes in aggregate demand while real shocks dominated in the 1970s however when wages are deflated by the consumer price index cpi the business cycle relationship is weak and not statistically significant over both subperiods these results contrast sharply with those of previous studies that do not isolate business cycle components

neoclassical demand for labour functions for six major economies can real factor prices and in particular the real wage explain the level of employment over the business cycle the question is of fundamental importance for macroeconomic policy and is of course the subject of longstanding controversy dunlop i938 failed to find the expected negative relationship between employment and the wage in the data and the subsequent debate is summarised in bodkin i969 crudely the data seemed to refute the competitive model of the labour market for if product markets are competitive and firms operate on their demand curves employment should be explained by real factor prices relative to product prices the capital stock and the state of technology to explain the lack of relationship barro and grossman i97i suggested that at times mutuality reinforcing quantity constraints could emerge in labour and output markets so that firms employed fewer workers than one would predict from the level of real wages and other relative prices however recently sargent i978 has attempted with some success to rehabilitate the demand for labour function by showing that costly adjustment of the workforce obscures the current relationship between the wage and labour demand while leaving it essentially intact in his account firms adjust slowly towards an employment level which is influenced by future expected real wages which might themselves reflect the past history of real wages his paper and the related one by neftci i978 was criticised by geary and kennan i979 for using retail prices to represent output prices and they showed for a number of countries that employment could not be satisfactorily explained by the real product wage taken on its own however geary and kennan failed to allow for the simultaneous effect of the real price of raw materials in symons i 982 one of us showed that allowing for this effect the real wage has a powerful elasticity about 2 but slow acting two year mean lag negative effect of the demand for labour in british manufacturing this was strong evidence but it was not completely conclusive the model fitted well only over subperiods and whereas the various breakdowns of the model could be ascribed to firms discounting certain transient shifts in the real wage there still seemed to be scope for reasonable doubt about the results however recently andrews and nickell i 982 a b working with annual rather than quarterly data and for the british economy as a whole have developed a demand for labour function with similar dynamics and with signifi

contracts job experience and cyclical labor market adjustments longitudinal estimates of the variability of individual wages hours and weeks worked over the course of changing demand states are provided for all workers generally and for workers of varied levels of job experience emphasis is placed on that part of job experience represented as years on current job a commonly used proxy for the magnitude of firm specific skills interpretation of resulting estimates in the context of the labor market contracting literature is attempted generally significant procyclical patterns are found for real weekly wages weekly hours and weeks worked the extent of weekly wage variability is much greater than is generally suggested in the literature furthermore workers with greater tenure exhibit greater cyclical wage and hours variability and less weeks variability finally empirical distinctions are drawn separately for white collar and blue collar as well as union and nonunion workers

real wages business cycles and the speed of adjustment of employment in manufacturing sectors of industrialized countries in a recent paper otani 1978 presents empirical evidence on the relationship between real wages and output in the manufacturing sectors of fourteen industrialized countries he estimates his coefficient 13 by regressing the percentage change in real wages on the percentage change in real output finding a negative relationship that is significant at the 5 level for six countries a non significant negative relationship for five countries and a positive relationship for three countries germany the netherlands and the united states otani puts forward but does not test a hypothesis concerning the inter country differences in the estimated values of 18 the present paper provides such a test and rejects otani s hypothesis otani offers a tentative explanation of the positive correlation between real wages and business cycles in germany the netherlands and the united states he hypothesizes that in these countries it is too costly for firms to fire the existing employees during a recession and hire new ones during a boom period otani 1978 p 303 otani does not test this hypothesis if we had data on the costs of adjusting employment levels in the different countries then we could provide a direct test of the hypothesis but such data are not available however an indirect test is possible following work by brechling 1965 brechling and o brien 1967 solow 1968 ireland and smyth 1970 and others there is a substantial body of literature concerned with the short run adjustment of labor demand to cyclical fluctuations the short run employment function literature this may be used to test otani s hypothesis otani s hypothesis involves the existence of a possible disequilibrium condition such that a firm may be producing at points off its long run labor demand schedule the short run employment function model is a model specifically designed to handle disequilibrium it has as its basic equation et e x e t et where e is the natural logarithm of employment e is the natural logarithm of desired or optimal employment which is a function of output and other variables and subscripts involving t indicate the time period the proportion of the logarithmic difference between the optimal and actual employment levels eliminated in any period is x where 0 x 1 employment is only on the long run labor demand schedule if the system is in equilibrium otherwise e t e and et et 0 thus the model does specifically allow for labor inputs off the demand for labor schedule in disequilibrium the smaller is x the slower is the speed of adjustment that is the less responsive is employment to output variations solow 1968 has shown that the speed of adjustment is slower the more costly it is to adjust employment otani s hypothesis is that countries with positive bs germany the netherlands and the united states have high costs of adjustment relative to countries with negative 8s it follows directly therefore that the otani hypothesis implies that the countries with positive f3s will have low values of x relative to those countries with negative f3 coefficients it is thus possible to use the short run employment function evidence to test the otani hypothesis table 1 gives otani s estimates of together with two sets of estimates of x xb is from brechling and o brien 1967 xs is from a set of results prepared as

ethics and investment management true reform what happened to ethical behavior in the era of the dot com the bubble enron and worldcom we were not involved in close ethical calls in these cases the lapses were great the conflicts many and the cost in terms of investor trust nearly unspeakable each time scandals occur market reforms result but the pattern is that despite their extensive nature the reforms do not bring us an insurance policy against misconduct true reform lies not in statutory or codified detail rather true reform comes from a strong moral compass that is applied by leaders who demonstrate ethical courage true reform requires a focus on doing more than the law requires and less than the law allows

why are wages cyclical in the 1970 s this article investigates cyclicality in real wages between 1969 and 1982 using panel study of income dynamics data there is little evidence that movements in and out of the labor market induced aggregate wage cyclicality during these years however cyclicality in the movement of workers between heterogeneous labor market sectors affected aggregate wage cyclicality while sector location is important sector selectivity is not correlated with wages yet even within sectors cyclicality is present in real wages over this time period and is the result of cyclicality in overall wage levels as well as in the coefficients associated with particular worker characteristics

the employment real wage relationship an international study the neoclassical and keynesian theories of employment both predict an inverse relationship between employment and real wages in the short run the observed correlation between employment and real wages however has usually failed to conform to this prediction dunlop 1938 and tarshis 1939 reported a positive correlation between real and money wages which given procyclical movement of money wages was interpreted as evidence against the theoretical prediction the statistical significance of these results was however challenged by ruggles 1940 and tobin 1948 more recent studies by kuh 1966 and bodkin 1969 failed to detect a significant relationship between real wages and employment these findings stimulated a series of contributions by solow and stiglitz 1968 barro and grossman 1971 1976 and others developing alternative models not apparently refuted by the evidence barro and grossman recast macro theory under the assumption that markets did not clear modigliani 1977 argued that the observed relationship between employment and real wages could be accounted for in an oligopolistic model of firm behavior thus both the competitive and equilibrium assumptions of the classical model were diagnosed as the sources of its apparent empirical refutation

demand shocks supply shocks and the cyclicality of real wages the behaviour of real wages over the business cycle has received increasiing attention in recent years the cyclicality of real wages constitues an important aspect of recent models of the business cycle however empirical studies undertaken to determine whether real wages are procyclical or countercyclical have reported conflicting findings in thiis paper we use vector autoregressions to analyse the cyclicality of real wages we find that the source of the disturbance plays a decisive role in the cyclical behaviour of real wages in particular we demonstrate that a supply shock generates procyclical real wages whereas a demand shock yields countercyclicality

implicit contracts a survey 7mplicit contracts resolve the distribution of uncertainty and utilization of specific human capital between risk averse workers and less risk averse firms incomplete contracts are required to yield involuntary layoffs in contract markets otherwise contracts are efficient and pareto optimal by construction there is a close relation between contract theory and neoclassical labor market theory contracts smooth consumption but increase the volatility of labor supply and labor utilization to demand disturbances because contractural insurance eliminates the income effects of socially diversifiable risks this result is similar to the intertemporal substitution hypothesis however the price mechanism in a contract is substantially different contracts embody a nonlinear two part pricing scheme the lump sum part allocates the income consumption consequences of risks and the marginal pricing part allocates production and labor utilization this implicit pricing mechanism is in all respects flexible though the observed average hourly wage combines both parts and may give the outward appearanceof rigidity furthermore the observed average wage rate in a contract does not reflect marginal conditions necessary for structural econometric estimation indivisibilities appear necessary to account for the split between work sharing and layoffs contracts with private information are also considered in the nonlinear pricing context this abstract was borrowed from another version of this item

wage variability in the 1970s sectoral shifts or cyclical sensitivity the recent debate questioning whether unemployment in the 1970s represents sectoral adjustment or cyclical variation is expanded to examine comparable causes of real wage variability using panel study of income dynamics panel data real wages respond more to persistent sectoral shocks than cyclical shocks in the 1970s making recent estimates of procyclical wage variability appear weak in perspective employing a model of endogenous sector specific individual skills older workers earning economic rents are shown to have the greatest wage response to sectoral shocks these results are consistent with the hypothesis that short run cyclical shocks may be met with hours adjustment as specified in implicit or explicit contracts but that persistent shocks require wage adjustment copyright 1989 by mit press

real wages and the business cycle the objectives of this review are threefold 1 to characterize the empirical literature on the cyclical behavior of real wages 2 to identify the sources of the differences in results across studies and 3 to enumerate key factors that determine the cyclicality of real wages given a host of measurement and methodological issues drawing firm conclusions is difficult but several generalizations can be made the estimated cyclicality of real wages depends crucially on the time period of analysis and the choice of whether to examine the production or the consumption wage composition effects play an important but complicated role as well

deals and delays firm level evidence on corruption and policy implementation times whether demands for bribes for particular government services are associated with expedited or delayed policy implementation underlies debates around the role of corruption in private sector development the grease the wheels hypothesis which contends that bribes act as speed money implies three testable predictions first on average bribe requests should be negatively correlated with wait times second this relationship should vary across firms with those with the highest opportunity cost of waiting being more likely to pay and facing shorter delays third the role of grease should vary across countries with benefits larger where regulatory burdens are greatest the data are inconsistent with all three predictions according to the preferred specifications ceteris paribus firms confronted with demands for bribes take approximately 1 5 times longer to get a construction permit operating license or electrical connection than firms that did not have to pay bribes and respectively 1 2 and 1 4

understanding real business cycles he 1 960s were a time of great optimism for macroeconomists many economists viewed the business cycle as dead the keynesian model was the reigning paradigm and it provided all the necessary instructions for manipulating the levers of monetary and fiscal policy to control aggregate demand inflation occurred if aggregate demand was stimulated excessively and unemployment arose if demand was insufficient the only dilemma faced by policymakers was determining the most desirable location along this inflation unemployment tradeoff or phillips curve the remaining intellectual challenge was to establish coherent microeconomic foundations for the aggregate behavioral relations posited by the keynesian framework but this was broadly regarded as a detail that should not deter policymakers in their efforts to stabilize the economy the return of the business cycle in the 1970s after almost a decade of economic expansion and the accompanying high rates of inflation came as a rude awakening for many economists it became increasingly apparent that the basic keynesian framework was not the appropriate vehicle for understanding what happens during a business cycle nor did it seem capable of providing the empirically correct answers to questions involving changes in the economic environment or changes in monetary or fiscal policy the view that keynesian economics was an empirical success even if it lacked sound theoretical foundations could no longer be taken seriously the essential flaw in the keynesian interpretation of macroeconomic phenomenon was the absence of a consistent foundation based on the choice theoretic framework of microeconomics two important papers one by milton friedman 1968 and the other by robert lucas 1976 forcefully demonstrated examples of