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Aggregate demand, idle time, and unemployment

Michaillat, Pascal and Saez, Emmanuel (2015) Aggregate demand, idle time, and unemployment. Quarterly Journal of Economics, 130 (2). pp. 507-569. ISSN 0033-5533

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Identification Number: 10.1093/qje/qjv006

Abstract

This article develops a model of unemployment fluctuations. The model keeps the architecture of the general-disequilibrium model of Barro and Grossman (1971) but takes a matching approach to the labor and product markets instead of a disequilibrium approach. On the product and labor markets, both price and tightness adjust to equalize supply and demand. Since there are two equilibrium variables but only one equilibrium condition on each market, a price mechanism is needed to select an equilibrium. We focus on two polar mechanisms: fixed prices and competitive prices. When prices are fixed, aggregate demand affects unemployment as follows. An increase in aggregate demand leads firms to find more customers. This reduces the idle time of their employees and thus increases their labor demand. This in turn reduces unemployment. We combine the predictions of the model and empirical measures of product market tightness, labor market tightness, output, and employment to assess the sources of labor market fluctuations in the United States. First, we find that product market tightness and labor market tightness fluctuate a lot, which implies that the fixed-price equilibrium describes the data better than the competitive-price equilibrium. Next, we find that labor market tightness and employment are positively correlated, which suggests that the labor market fluctuations are mostly due to labor demand shocks and not to labor supply or mismatch shocks. Last, we find that product market tightness and output are positively correlated, which suggests that the labor demand shocks mostly reflect aggregate demand shocks and not technology shocks.

Item Type: Article
Official URL: http://qje.oxfordjournals.org/
Additional Information: © 2015 The Authors © CC BY 4.0
Divisions: Economics
Centre for Economic Performance
Subjects: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HD Industries. Land use. Labor
JEL classification: E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E10 - General
E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E24 - Macroeconomics: Employment; Unemployment; Wages; Intergenerational Income Distribution (includes wage indexation)
E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E30 - General
J - Labor and Demographic Economics > J2 - Time Allocation, Work Behavior, and Employment Determination and Creation; Human Capital; Retirement
J - Labor and Demographic Economics > J6 - Mobility, Unemployment, and Vacancies > J64 - Unemployment: Models, Duration, Incidence, and Job Search
Sets: Departments > Economics
Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Date Deposited: 07 May 2015 11:00
Last Modified: 20 Mar 2019 02:40
Projects: ES/K008641/1
Funders: Center for Equitable Growth at the University of California Berkeley, British Academy, Economic and Social Research Council, Banque de France, Institute for New Economic Thinking, W.E. Upjohn Institute for Employment Research.
URI: http://eprints.lse.ac.uk/id/eprint/61832

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