Arnold Kling says it's W/P.
"4. When it comes to aggregate supply and demand, the regulating mechanism is what is called the real wage rate, which means the wage rate adjusted for the general level of prices (or the cost of living). When prices go up, the real wage rate falls, and vice-versa. When the real wage rate falls, firms hire more workers, raising output and employment. That is the aggregate supply that goes along with aggregate demand."
I disagree. (But I'm not sneering, because Arnold is far too bright and original to sneer at, ever.)
In a barter economy, and one with no financial assets, there is a market, or set of markets, in which labour is traded for output. The supply of labour is the demand for output. And the demand for labour is the supply of output. The aggregate demand function is just the flip-side of the labour supply function. The aggregate supply function is just the flip-side of the labour demand function.
Yep. In that economy, Arnold is right. It's the real wage that equilibrates the labour market and the output market. They are one and the same market.
(Some) Keynesians will disagree with Arnold. Those Keynesians add financial assets to the mix. The right real wage is needed to clear the labour market. But you need the right real interest rate r to clear the output market. If there's an excess demand for bonds that means an excess supply of desired savings over desired investment, which means an excess of AS over AD.
Yep. In that economy, those Keynesians are right. It's the real interest rate that clears the bond market and the output market. They are one and the same market.
Monetary disequilibrium theorists will disagree with those Keynesians. We add monetary exchange to the mix. We don't buy and sell output for labour. We don't buy and sell output for bonds. We buy and sell output for money -- the medium of exchange. We buy and sell everything for money -- labour, bonds, and output. If there's an excess demand for money, so the desired stock of money exceeds the actual stock of money, people will be trying to sell more of everything than they buy of everything. An excess of AS over AD means an excess demand for money. It's the real stock of money M/P that must adjust to equilibrate AD and AS.
If a binding minimum wage law sets W/P too high, there will be excess supply of labour. People can't sell as much labour as they want to. If a binding pro-usury law sets r too high there will be excess demand for bonds. People can't buy as many bonds as they want to. But if M/P is right, AS will still equal AD. The output market clears, even if the labour market and bond market don't.
Arnold's still right in a way. If M/P adjustment can be taken for granted, then if people want less labour and less output, or firms want more output and more labour, then W/P will adjust to coordinate their conflicting desires.
And those Keynesians are still right in a way. If M/P adjustment can be taken for granted, then if people want less consumption today and more consumption tomorrow, or firms want less investment today and more consumption today, then r will adjust to coordinate their conflicting desires.
And in the long run M/P adjustment can be taken for granted. And W/P adjusts if we decide we want to consume more leisure and buy fewer Ipads and BMWs. And r adjusts if we want more consumption tomorrow and less consumption today. But we can't take M/P adjustment for granted in the short run.