Financial constraints and unemployment equilibrium

This paper aims to show (1) that the IS/LM model will be a coherent solution to Keynes’s analysis of unemployment, if the relaxation of the general equilibrium framework is based solely on exogenous price and quantity constraints; (2) that the consequent determination of unemployment equilibria is analytically fragile and does not support Keynes’ attempt to reduce the standard approach to a particular case of his “general theory”; and (3) that a more robust determination of unemployment equilibria has to be based on the integration of credit rationing into a general equilibrium model. To illustrate points (1) and (2), we review some of the traditional macroeconomic models of the neoclassical synthesis, and we show that the problems bequeathed by these models are only partially solved by the strand of the new Keynesian economics based on market imperfections and endogenous rigidities. To illustrate point (3) we build a simple general equilibrium model in which prices are – in principle – perfectly flexible and credit rationing implies unemployment equilibria. Apart from the crucial role played by the credit market, our model is very similar to that developed by the neoclassical synthesis.