High wages, credit rationing and unemployment in a monetary economy

By Guglielmo Forges Davanzati, Andrea Pacella

PKES Working Paper 0801

January 2008
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The aim of this paper is to analyse the theoretical links between a policy of high wages and the level of employment in the theoretical framework of the monetary theory of production (MTP). The ‘high-wage effect’ will be assumed to be operating, i.e. a rise in wages via external intervention induces firms to react via technical advancement, which, in turn, increases the quantity and the quality of capital and hence the level of employment. Credit rationing will also be taken into consideration. Insofar as high wages increase profits, smaller firms facing credit rationing make lower profits than bigger firms, thus resulting in a potential process of raising the industrial concentration ratio. Therefore, in a singleperiod analysis, a high-wage policy is effective for the purpose of increasing employment only if the banking system behaves in an accommodating way. The bankruptcies of the smaller firms generate a greater demand to the benefit of the bigger firms, thus giving rise to a theoretical solution of the so-called paradox of profits.

Keywords: monetary theory of production, credit rationing, wages, profits, employment

JEL classification: E12 E40 J01