DP9668 Labor Force Participation and Monetary Policy in the Wake of the Great Recession

Author(s): Christopher Erceg, Andrew Levin
Publication Date: September 2013
Keyword(s): labor force, policy tradeoffs, simple rules, unemployment rate
JEL(s): E24, E32, E52, J21
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9668

In this paper, we provide compelling evidence that cyclical factors account for the bulk of the post-2007 decline in the U.S. labor force participation rate. We then proceed to formulate a stylized New Keynesian model in which labor force participation is essentially acyclical during "normal times" (that is, in response to small or transitory shocks) but drops markedly in the wake of a large and persistent aggregate demand shock. Finally, we show that these considerations can have potentially crucial implications for the design of monetary policy, especially under circumstances in which adjustments to the short-term interest rate are constrained by the zero lower bound.