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Two more widely held views

Summary:
In a recent post, I discussed two widely held views that seem inconsistent. I am indebted to Ryan Bourne for pointing to another example. Unemployment in Western Europe was quite low during the 1960s. During the 1980s, unemployment rose to very high levels, and never fell back again, even after their economies had recovered from the two oil shock recessions. This led to theories of “hysteresis”, the idea that a severe slump could cause permanently high unemployment, as workers who were unemployed for long periods became less employable. The policy implication is that it is especially important to have demand stimulus during recessions, to prevent a permanent rise in unemployment. This argument was used for aggressive stimulus during the Great Recession. Today, we

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In a recent post, I discussed two widely held views that seem inconsistent. I am indebted to Ryan Bourne for pointing to another example.

Unemployment in Western Europe was quite low during the 1960s. During the 1980s, unemployment rose to very high levels, and never fell back again, even after their economies had recovered from the two oil shock recessions. This led to theories of “hysteresis”, the idea that a severe slump could cause permanently high unemployment, as workers who were unemployed for long periods became less employable. The policy implication is that it is especially important to have demand stimulus during recessions, to prevent a permanent rise in unemployment.

This argument was used for aggressive stimulus during the Great Recession. Today, we see almost the opposite argument. Despite the unusual length and depth of the Great Recession, many pundits claim that the natural rate of unemployment in the US and in many other developed countries has fallen to historically low levels. This is cited as justification for additional monetary stimulus.

I fear that people will misinterpret this post. I don’t believe these arguments are necessarily wrong. Long time readers know that I favored additional monetary stimulus during the Great Recession. I also agree with the claim that the natural rate of unemployment has recently declined in the US and some other nations.

But it is important to be consistent. The recent trends in unemployment cast doubt on the hysteresis theory. It does not seem like the Great Recession permanently damaged the US labor market. If you prefer another labor market measure, such as the employment ratio for prime age workers, that’s also back to pre-recession levels:

Two more widely held views

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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