Paradox of Hysteresis and Real Wage Flexibility in Australia

This study examines the paradoxical coexistence of high unemployment rates and real wage flexibility during the period 1966-92 in Australai. The neoclassical paradigm postulates that real wage flexibility is a per-requisite to operate at the natural rate or full employment level of output. The Keynesian paradigm blames the downward stickiness of nominal wages for the prevalence of unemployment. However, both paradigms agree that the divergence of the unemployment rate for the natural rate is a short-run phenomenon and in the long-run the unemployment reverts the natural rate. The New Keynesians and Neo Keynesians, while dissenting on the speed of reversal agree that in the long run the unemployment rate will gravitate to the natural rate.The concept of NAIRU (non-accelerating inflation rate of unemployment) attempts to synthesize the conflicting paradigms and explain the non reversal to the natural rate in terms of socioeconomic policy variables. The non-reversal of the unemployment rate to the natural rate and its persistence has a similarity to the concept of hysteresis in physics and implies that unemployment rate is dependent on its past state. Unit root and cointegration analysis are deployed to tests the degree of real wage flexibility and prevalence of hysteresis in the Australian unemployment rate during the study period