Involuntary unemployment in overlapping generations model due to instability of the economy

TL;DR

This paper demonstrates that involuntary unemployment, as discussed by Keynes, can be explained by economic instability in a three-generation overlapping model, where wage falls lead to further employment decline due to negative real balance effects.

Contribution

It introduces a three-generation overlapping model showing that economic instability causes involuntary unemployment, highlighting the role of the negative real balance effect.

Findings

Involuntary unemployment arises from economic instability.

Instability is linked to the negative real balance effect.

Wage reductions exacerbate unemployment due to this instability.

Abstract

The existence of involuntary unemployment advocated by J. M. Keynes is a very important problem of the modern economic theory. Using a three-generations overlapping generations model, we show that the existence of involuntary unemployment is due to the instability of the economy. Instability of the economy is the instability of the difference equation about the equilibrium price around the full-employment equilibrium, which means that a fall in the nominal wage rate caused by the presence of involuntary unemployment further reduces employment. This instability is due to the negative real balance effect that occurs when consumers' net savings (the difference between savings and pensions) are smaller than their debt multiplied by the marginal propensity to consume from childhood consumption.