Joseph E. Stigiltz International Monetary Fund/Flickr

Stiglitz’s Sticky Prices

For decades, the assumption underlying mainstream economics was that Adam Smith’s invisible hand worked its magic seamlessly, keeping markets in equilibrium during changes in supply and demand. It was Joseph Stiglitz who showed that the invisible hand “is invisible at least in part because it is not there.”

WASHINGTON, DC – For a long time, the assumption underlying much of mainstream economics was that the invisible hand worked its magic seamlessly. Prices moved smoothly up as demand outpaced supply and rushed back down when the tables were turned, keeping markets in equilibrium.

To be sure, many observers realized the truth was actually quite different – that prices, and wages and interest rates in particular, were often sticky, and that this sometimes prevented markets from clearing. In labor markets, this meant unemployed workers facing prolonged job searches. But the response by others in the field was that what their colleagues described as “unemployment” did not truly exist; it was voluntary, the result of stubborn workers refusing to accept the going wage.

Among those who recognized the reality of involuntary unemployment were John Maynard Keynes and Arthur Lewis, who incorporated it into his model of dual economies, in which urban wages do not respond to labor-supply gluts and remain above what rural workers earn. Both Keynes and Lewis used the stickiness of prices extensively in their work. But even for them, the concept was only an assumption; they never managed to explain why wages and interest rates so often resisted the pressures of supply and demand.

To continue reading, please log in or enter your email address.

Registration is quick and easy and requires only your email address. If you already have an account with us, please log in. Or subscribe now for unlimited access.

required

Log in

http://prosyn.org/l8h431q;
  1. An employee works at a chemical fiber weaving company VCG/Getty Images

    China in the Lead?

    For four decades, China has achieved unprecedented economic growth under a centralized, authoritarian political system, far outpacing growth in the Western liberal democracies. So, is Chinese President Xi Jinping right to double down on authoritarianism, and is the “China model” truly a viable rival to Western-style democratic capitalism?

  2. The assembly line at Ford Bill Pugliano/Getty Images

    Whither the Multilateral Trading System?

    The global economy today is dominated by three major players – China, the EU, and the US – with roughly equal trading volumes and limited incentive to fight for the rules-based global trading system. With cooperation unlikely, the world should prepare itself for the erosion of the World Trade Organization.

  3. Donald Trump Saul Loeb/Getty Images

    The Globalization of Our Discontent

    Globalization, which was supposed to benefit developed and developing countries alike, is now reviled almost everywhere, as the political backlash in Europe and the US has shown. The challenge is to minimize the risk that the backlash will intensify, and that starts by understanding – and avoiding – past mistakes.

  4. A general view of the Corn Market in the City of Manchester Christopher Furlong/Getty Images

    A Better British Story

    Despite all of the doom and gloom over the United Kingdom's impending withdrawal from the European Union, key manufacturing indicators are at their highest levels in four years, and the mood for investment may be improving. While parts of the UK are certainly weakening economically, others may finally be overcoming longstanding challenges.

  5. UK supermarket Waring Abbott/Getty Images

    The UK’s Multilateral Trade Future

    With Brexit looming, the UK has no choice but to redesign its future trading relationships. As a major producer of sophisticated components, its long-term trade strategy should focus on gaining deep and unfettered access to integrated cross-border supply chains – and that means adopting a multilateral approach.

  6. The Year Ahead 2018

    The world’s leading thinkers and policymakers examine what’s come apart in the past year, and anticipate what will define the year ahead.

    Order now