John Maynard Keynes, Joan Robinson and the prospect theory approach to money wage determination

Abstract

In the 1930s, John Maynard Keynes and Joan Robinson observed a flex–fix sequence of money wage adjustment, which is changes in aggregate demand may initially change money wages but then money wages will settle at new levels even if unemployment is high. Their discussion of this pattern alluded to the importance of loss aversion in wage setting. This paper shows how loss aversion in wage setting can explain the flex–fix sequence of money wage behaviour in a way which is consistent with the observations and ideas of Keynes and Robinson.