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The economy is in underemployment equilibrium, and it is not a mistake. So what drives the economy to this underemployment equilibrium where workers are involuntarily unemployed?

Modern Monetary Theory (MMT) shows us clearly that involuntary unemployment arises when the private sector, in aggregate, desires to earn the monetary unit of account, but doesn't desire to spend all it earns. Firms do not hire because they cannot sell the output that would be produced. In this situation, nominal (or real) wage cuts per se do not clear the labour market, unless those cuts somehow eliminate the desire of the private sector to net save, and thereby increase (investment) spending.

The only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save and eliminate unemployment is the government sector. It does this by (deficit) spending. The obvious conclusion is that unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.


Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Jan 26th, 2011 at 05:13:56 AM EST
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