Transaction Costs in the Theory of Unemployment

Abstract

This paper addresses the problem of accounting theoretically for the persistence of large-scale unemployment. It briefly reviews some of the well-known shortcomings of the Keynesian account based upon sticky wages and prices and upon Robert Clower's (1965) concept of effective demand, arguing that these shortcomings can be seen as a failure explicitly to integrate transaction costs into the theory of unemployment. The main constructive contribution of the paper is an example of a simple macro model, along the lines of Robert Barro and Herschel Grossman (1971), in which transaction costs are made explicit. An essential part of this example is an externality of the sort suggested by Peter Diamond (1982). The example provides an account of persistent unemployment with many Keynesian features, yet without some of the Keynesian shortcomings. In particular it assumes perfect wage and price flexibility.

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