Abstract
WHAT DETERMINES the unemployment rate? In answering this question,
mainstream economics draws a sharp distinction between the short run and
the long run. According to the conventional view, short-run movements in
unemployment are strongly influenced by monetary policy and other determinants
of aggregate demand. In the long run, however, unemployment
returns to a natural rate or NAIRU (the nonaccelerating-inflation rate of
unemployment), which is determined by labor market frictions. The
NAIRU can change over time for microeconomic reasons, such as changes
in labor market institutions. But the conventional wisdom holds that the
NAIRU is unaffected by aggregate demand, and thus that demand does not
influence long-run unemployment trends.
This paper argues that this conventional view is wrong. Monetary policy
and other determinants of aggregate demand have strong effects on longrun
as well as short-run movements in unemployment. And this is not just
a theoretical point. Over the last twenty years the behavior of demand
accounts for much of the differences across countries in the evolution of
unemployment.
