Question

Explain why Keynesians argue that a higher minimum wage will not cause unemployment and will likely lead to a reduction in unemployment.

Answer 1

Keynesian economics is a theory which says that the government should increase demand to boost growth. Keynesian believes that the consumer demand is the primary driving force in an economy. So as a result, the theory support expansionary fiscal policy. Their main tools are government spending on infrastructure, unemployment benefits and education.

There are several types of unemployment. Cyclical unemployment exists when individual lose their jobs as a result of down turn in aggregate demand. If the decline in aggregate demand is persistent and the unemployment is long term, it is called Keynesian unemployment. On the other hand classical unemployment is when wages are too high. It is also called real wage unemployment

There are two strategies for reducing unemployment. First is demand side policies to reduce demand deficient unemployment. That is, it is the unemployment caused by recession. Second is supply side policies to reduce structural unemployment. Keynes argued that the government spending was necessary to maintain full employment.

The important element of the Keynesian economics is the idea that macroeconomy can be in disequilibrium for considerable time. Their economics advocate higher government spending which helps to recover from a recession. Keynes did not advocate allowing higher inflation. During periods of growth, Keynes argued inflation should be kept under control.

Classical economic theory suggested that any fall in investment would lead to lower interest rates. So that this fall in interest rates would reduce savings, increase investment and cause the economy to return to a new equilibrium of full employment. According to classical theory labour market should clear. In this unemployment is due to wages being artificially kept above equilibrium through minimum wages. According to them a solution to unemployment is to cut wages and allow wages to clear. But Keynes argued that this is unsatisfactory.

Because even in the absence of unions and minimum wages, workers would resist nominal wage cuts. Also cut in wages would not solve equilibrium. These lower wages would further depress income and spending leading to lower aggregate demand and therefore lower demand for labour. Keynes contribution was done to show the interaction between labour market and the national economy and also not to treat them labour market in isolation.