Andrew T. LevinBack to index

  • Labor Force Participation and Monetary Policy in the Wake of the Great Recession

    Abstract

    In this paper, we provide compelling evidence that cyclical factors account for the bulk of the post-2007 decline in the U.S. labor force participation rate. We then proceed to formulate a stylized New Keynesian model in which labor force participation is essentially acyclical during "normal times" (that is, in response to small or transitory shocks) but drops markedly in the wake of a large and persistent aggregate demand shock. Finally, we show that these considerations can have potentially crucial implications for the design of monetary policy, especially under circumstances in which adjustments to the short-term interest rate are constrained by the zero lower bound.

    Introduction

    A longstanding and well-established fact in labor economics is that the labor supply of primeage and older adults has been essentially acyclical throughout the postwar period, while that of teenagers has been moderately procyclical; cf. Mincer (1966), Pencavel (1986), and Heckman and Killingsworth (1986). Consequently, macroeconomists have largely focused on the unemployment rate as a business cycle indicator while abstracting from movements in labor force participation. Similarly, the literature on optimal monetary policy and simple rules has typically assumed that unemployment gaps and output gaps can be viewed as roughly equivalent; cf. Orphanides (2002), Taylor and Williams (2010).

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