KEYNESIAN AND NEW-KEYNESIAN THEORIES OF UNEMPLOYMENT AND THE BEHAVIOUR OF REAL WAGES  

As  mentioned  above, two  phenomena  about the  labour market  need  to  be explained: the persistence  if unemployment and  the moderately pro-cyclical behaviour  of  real wages. When  aggregate demand increases, labour markets respond typically by  a larger increase  in  employment and a relatively smaller increase in real wages, i.e.,  quantities respond more than prices. But real wages do respond cyclically,  however moderately. 

This point helps us to understand the difference between Keynesian and New- Keynesian  theories of  unemployment.  Though  both  kinds  of  theories help explain persistent unemployment, it is only some of the new-Keynesian theories that explain why wages behave pro-cyclically, though only moderately so. The Keynesian theory clearly  implies that  wages behave counter-cyclically. This follows from  the assumption of a  constant nominal wage. Given the nominal wage  rate W,  the real wage W/P  falls during an expansion as the price level P gradually increases. It  is this fall in  the real wage that induces firms to employ more  labour and produce higher output as  aggregate demand increases. During contraction, on the  other  hand, real wages  rise as prices fall, nominal wages remaining unchanged.  The Keynesian model  thus implies  a counter-cyclical behaviour  of  real wages.  This is  not  in  accordance with  the  empirically observed behaviour of real wages. In real world we  see that real wage increases during periods of boom and decreases during  recession. The new-Keynesian models imply an advance over the Keynesian model to the extent  that  they  imply a pro-cyclical behaviour  for  real wages,  in  accordance with empirical observations.