IS SHE KIDDING WITH THIS COMMENT?? WE ARE IN DEEP TROUBLE!!!
President Barack Obama's choice of Janet Yellen to head the Federal Reserve was surely bolstered by the fact that her concerns about unemployment outweigh her concerns about inflation. It must have gratified him, then, to learn that her most famous theory attempts to pinpoint the specific cause behind unemployment.
Co-written with her husband, Nobel-winning economist George Akerlof, Yellen's most widely cited paper is borne out of a simple premise: "if people do not get what they think they deserve, they get angry." Yellen and Akerlof go on to argue that workers who receive less than what they perceive to be a fair wage will purposely work less hard as a way to take revenge on their employer. And the worse they are paid, the less hard they will work. Or, as the paper puts it, "workers proportionally withdraw effort as their actual wage falls short of their fair wage."
In the 1990 paper, the economists christen their theory "the fair wage-effort hypothesis," and go on to explain why the phenomenon could explain unemployment.
(Read more: Stocks shrug off Yellen, so I'm getting short: Pro)
But before that is elucidated, it is important to understand that under the admittedly "rudimentary model" used by these economists, unemployment is a bit of a riddle. After all, if the cost of hiring a worker is greater than the value that worker adds, then firms will hire no one.
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