Answer to Question #125558 in Macroeconomics for Nil Su Cetinoglu

Question

Suppose that, within the Neoclassical - Keynesian Synthesis Model, the economy is initially
suffering from unemployment. The government knows that in the long-run the economy will reach
full employment level through its own dynamics.
However the government would not like to wait for a long time for this adjustment process to
complete itself and wants to make this process shorter.
Yet the government would also like keep the price level and the rate of interest at their present level.
Could the government achieve these three goals? Why or why not? Explain clearly.

Answer 1

According to neoclassical synthesis, the reason for underemployment is the inflexibility of wages. To achieve full employment, it is necessary to lower the wage rate to a level at which entrepreneurs can hire everyone. This can be achieved by raising prices, raising real wages and lowering nominal wages. However, the implementation of such a scenario is possible only when economic agents do not distinguish between nominal and real values, which contradicts the principle of rationality and awareness.