Aggregate Demand and the Dynamics of Unemployment

41 Pages Posted: 6 Jun 2016

See all articles by Edouard Schaal

Edouard Schaal

New York University (NYU), Department of Economics

Mathieu Taschereau-Dumouchel

Cornell University - Department of Economics

Date Written: June 3, 2016

Abstract

We introduce an aggregate demand externality into the Mortensen-Pissarides model of equilibrium unemployment. Because firms care about the demand for their products, an increase in unemployment lowers the incentives to post vacancies which further increases unemployment. This positive feedback creates a coordination problem among firms and leads to multiple equilibria. We show, however, that the multiplicity disappears when enough heterogeneity is introduced in the model. In this case, the unique equilibrium still exhibits interesting dynamic properties. In particular, the importance of the aggregate demand channel grows with the size and duration of shocks, and multiple stationary points in the dynamics of unemployment can exist. We calibrate the model to the U.S. economy and show that the mechanism generates additional volatility and persistence in labor market variables, in line with the data. In particular, the model can generate deep, long-lasting unemployment crises.

Keywords: demand, unemployment, nonlinear dynamics, volatility

JEL Classification: E24, D83

Suggested Citation

Schaal, Edouard and Taschereau-Dumouchel, Mathieu, Aggregate Demand and the Dynamics of Unemployment (June 3, 2016). Available at SSRN: https://ssrn.com/abstract=2788343 or http://dx.doi.org/10.2139/ssrn.2788343

Edouard Schaal

New York University (NYU), Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States

Mathieu Taschereau-Dumouchel (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States

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