Involuntary Unemployment in Diamond-Type Overlapping Generations Models

Thus far involuntary unemployment does not occur in Diamond-type Overlapping Generations models. In line with Keynesian macroeconomics, involuntary unemployment is traced back to aggregate demand failures. While macro-economists majority refers aggregate demand failures to sticky prices, a minority attributes lacking aggregate demand to not perfectly flexible aggregate investment. The chapter investigates how an independent aggregate investment function causes involuntary unemployment under perfectly flexible competitive wage and interest rates in a Diamond-type neoclassical growth model with public debt and human capital accumulation. Moreover, it is shown that a higher public debt to output ratio enhances output growth and reduces involuntary unemployment.

Fiscal Policy as a Solution to Involuntary Unemployment

We show the existence of involuntary unemployment based on consumers’ utility maximization and firms’ profit maximization behavior under monopolistic competition with increasing, decreasing or constant returns to scale technology using a three-periods overlapping generations (OLG) model with a childhood period as well as younger and older periods, and pay-as-you-go pension for the older generation, and we analyze the effects of fiscal policy financed by tax and budget deficit (or seigniorage) to achieve full-employment under a situation with involuntary unemployment. Under constant prices we show the following results. 1) If the realization of full employment will increase consumers’ disposable income, in order to achieve full-employment from a state with involuntary unemployment, we need budget deficit (Proposition 1). 2) If the full-employment state has been achieved, we need balanced budget to maintain full-employment (Proposition 2). We also consider fiscal policy under inflation or deflation. Additionally, we present a game-theoretic interpretation of involuntary unemployment and full-employment. We also argue that if full employment should be achieved in equilibrium, the instability of equilibrium can be considered to be the cause of involuntary unemployment.

Involuntary Unemployment as a Nash Equilibrium and Fiscal Policy for Full Employment

This study aimed to provide a game-theoretic interpretation of the analyses of involuntary unemployment by deficiency of aggregate demand and fiscal policy to achieve full employment using an overlapping generations model. We showed that involuntary unemployment is in a Nash equilibrium of a game with a firm and consumers. Moreover, we showed that full employment can be achieved through fiscal policies that create budget deficits in recessionary conditions with involuntary unemployment. Once full employment is achieved, it can be sustained without a budget deficit.

Negative Real Balance Effects in the Presence of Involuntary Unemployment

We examine positive or negative real balance effect (or so-called Pigou effect) by falls in the nominal wage rate and the prices of the goods in situations where there is involuntary unemployment using a three-generations overlapping generations model with childhood period and pay-as-you go pension system for the older generation consumers. We will show that if the net savings of the younger generation consumers are larger than their debts due to consumption in their childhood period, there exists positive real balance effect and the employment increases by a fall in the nominal wage rate; on the other hand, if the net savings of the younger generation consumers are smaller than their debts, there exists negative real balance effect and the employment decreases by a fall in the nominal wage rate.