Knowledge that Transforms

For those who measure the greatness of a year by the assumptions and isms that have perished within its span, 1981 will be judged one of the great ones in theoretical macroeconomics. It is the year, I shall argue, of the demise of monetarism; if not the demise, then at least its demotion to a temporary position pending a more promising replacement. But monetarism was not the only fatality of 1981. It is also the year in which the efficacy of fiscal policy was shaken to its foundations. It is conceivable that the idea of stimulating (or contracting) employment by means of fiscal policy measures may yet be reborn in some sturdier theoretical frame. But, for now, the old Keynesian notion of fiscal stimulus is so beset by doubts that fiscal policy, if not truly incapacitated, is in a deactivated status. Thus theoretical macroeconomics is today in a state of crisis. The hope, of course, is that the crisis signals a transition, in a direction not yet foreseen, to some Eriksonian stage of new competence and restored confidence.

Recently in this Review, John Pencavel and P. J. Lloyd have given insights into the measurement of real wages. Their work is an application of the concepts of true cost of living indices to a joint labor supply and commodity demand decision. Pencavel (1977) and Lloyd (1979) offer several forms of real wage indices which are derived from explicit functional forms for utility. This paper examines the theory of real wage indices in a more general setting and derives bounding indices which are independent of the functional form for utility.