The Issue of Unemployment

As we recall, the Monetarists and their successors the "New Classical" economists aimed to reformulate the older "classical" economics Keynes had rejected because he saw it as being unable to account for unemployment and the Great Depression.

So the New Classical assumption was that production is determined by (microeconomic) supply and demand. This was the very view that Keynes and the Keynesians had rejected, and they had rejected it on the grounds that it didn't fit the facts. The fact it didn't fit was unemployment. Remember, Keynesians interpreted unemployment as an excess supply of labor. "Supply and demand" can only explain production if supply equals demand -- at least for a key strategic input, like labor. But unemployment (excess supply of labor) means that supply isn't equal to demand.

In the terms of the "Reasonable Dialog," the observation that unemployment can exist and can be the central economic problem of society certainly does "undercut" the idea that supply and demand determines production. But it only "undercuts" the supply and demand approach if we interpret unemployment as an excess supply of labor. The "New Classical" economists aimed to undercut that interpretation -- to argue that unemployment should not be interpreted as an excess supply of labor -- and thus to restore the "supply and demand" approach to credibility.

But if unemployment is not an excess supply of labor, then what is it? That was the question the "New Classical" economists had to answer.