DP16535 The Elusive State of Full Employment
During the expansion phase of the business cycle unemployment declines towards levels that are usually associated to the natural rate of unemployment. Unfortunately, those low levels of unemployment are short lived. In the last 60 years, the US has not witnessed a long period of stable and low unemployment. We argue that this result is consistent with an asymmetric view of the business cycles (as in Friedman’s plucking model) where many expansions are unfinished business, they end too early. The speed of labor market recovery is too slow and before the economy reaches full employment a recession starts, either because of imbalances or bad luck. Our analysis has implications for how we think about labor market slack and potential output. From a policy perspective it calls for a focus on faster recoveries while avoiding the type of imbalances that can be the seed of the next crisis.