A New Theory of Aggregate Supply

Roger E. A. Farmer

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Monetary Policy and Economic Impact Economic Theory and Policy Economic theories and models

Abstract

Macroeconomic theory contains two com-peting explanations of business cycle fluc-tuations. According to the intertemporal substitution mechanism (ITS), observed vari-ations in employment represent the opti-mal response of labor supply to (misper-ceived) variations in the expected real rate of interest. A competing theory is offered by the literature on overlapping contracts that at-tributes employment variations to contracted nominal wage rigidities. Such rigidities pre-vent prices from adjusting in a way that would allow quantities to mimic the theoreti-cal predictions of the Walrasian market-clearing model. Both of these theories in-

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References

1981Credit Rationing in Markets with Imperfect Information 1974Are Government Bonds Net Wealth?1979Incentive Compatibility and the Bargaining Problem 1983Limited liability contracts between principal and agent 1981Resource Allocation Under Asymmetric Information 1980Comparison of Interwar and Postwar Business Cycles: Monetarism Reconsidered 1978A New Representation of Preferences over "Certain x Uncertain" Consumption Pairs: The "Ordinal Certainty Equivalent" Hypothesis 1982Time Series Representations of Economic Variables and Alternative Models of the Labour Market

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