Two more widely held views
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: