Aggregate Demand, Idle Time, and Unemployment

Authors

Pascal Michaillat, London School of Economics
Emmanuel Saez, University of California - Berkeley

Publication Date

7-24-2014

Series

Upjohn Institute working paper ; 14-214

**Published Version**

In The Quarterly Journal of Economics 130(2): 507-569

DOI

10.17848/wp14-214

Abstract

This paper develops a model of unemployment fluctuations. The model keeps the architecture of the Barro and Grossman (1971) general disequilibrium model but replaces the disequilibrium framework on the labor and product markets by a matching framework. On the product and labor markets, both price and tightness adjust to equalize supply and demand. There is one more variable than equilibrium condition on each market, so we consider various price mechanisms to close the model, from completely flexible to completely rigid. With some price rigidity, aggregate demand influences unemployment through a simple mechanism: higher aggregate demand raises the probability that firms find customers, which reduces idle time for firms’ employees and thus increases labor demand, which in turn reduces unemployment. We use the comparative-statistics predictions of the model together with empirical measures of quantities and tightnesses to re-examine the origins of labor market fluctuations. We conclude that (1) price and real wage are not fully flexible because product and labor market tightness fluctuate significantly; (2) fluctuations are mostly caused by labor demand and not labor supply shocks because employment is positively correlated with labor market tightness; and (3) labor demand shocks mostly reflect aggregate demand and not technology shocks because output is positively correlated with product market tightness.

Issue Date

July 2014

Sponsorship

Center for Equitable Growth at the University of California, Berkeley, the British Academy, the Economic and Social Research Council, the Banque de France foundation, the Institute for New Economic Thinking, the W.E. Upjohn Institute for Employment Research Early Career Research Award 12-137-09

Subject Areas

LABOR MARKET ISSUES; Job security and unemployment dynamics; UNEMPLOYMENT, DISABILITY, and INCOME SUPPORT PROGRAMS