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By Jacques Drèze

Top students study a number particular departures from common equilibrium conception that have major implications for the macroeconomic research of either built and constructing economies. Jacques Dr?ze considers uncertainty and incomplete markets and Nobel Laureate Robert Solow relates progress thought to the macroeconomic framework. different concerns tested are the consequences for macro-policy of latest learn, together with Joseph Stiglitz's caution at the lost zeal for monetary marketplace liberalization which in part engendered the East Asian and Russian crises.

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This is my own interpretation of the flourishing literature on multiple equilibria, sunspots, animal spirits, self-fulfilling expectations, endogenous 42 The General Framework business cycles and the like, to which I am adding a chapter on incomplete markets and price rigidities. The link from volatility to under-utilization of resources and persistence has a static and a dynamic aspect. First, availability of inputs sets an upper limit to output, but there is no lower limit, so that volatility manifests itself as under-utilization (or else as inflationary pressure).

3 depicts the structure of this chapter. I shall outline two implications of market incompleteness: volatility of demand, especially investment; then wage and price rigidities. These are microeconomic issues, so land is in sight and navigation is easy. Afterwards, I shall turn to macroeconomic considerations. 2 Incomplete markets breed demand volatility At a point in time, economic agents observe some, but not all, aspects of the economic environment. Their information is asymmetric. Based on what they observe, they hold expectations about future states and associated economic developments.

The practice in the seventies of issuing loans at variable rates was an inefficient risk-sharing arrangement, which left the borrowers exposed when interest rates skyrocketed in the late seventies and early eighties. There remains scope for corrective action today; see Drèze (1999d). How does this reasoning explain wage rigidities in the face of unemployment? We know from the literature on implicit labour contracts 5 that employment in a firm facing cost or demand uncertainties is efficient provided the marginal value product of labour matches in all states its opportunity cost, which is equal to market wages under full employment, to reservation wages otherwise.

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