Michael Blog

With regard to current concerns, probably the most relevant paper is Blanchard and Diamond on the Beveridge Curve — the relationship between job vacancies and unemployment.

What’s the moral of that paper? It shows that structural unemployment is a real issue, and that the volume of structural unemployment shifts over time. It also shows, however, that short-term movements in unemployment are overwhelmingly the result of overall shocks to demand — in effect, Keynesian business cycles.

And given the debate now underway about whether we’re mainly facing a rise in cyclical or structural unemployment, it’s definitely worth noting that they give us a simple way to make that distinction:

The economy, however, is subject to two types of shocks with quite different effects. Changes in the level of aggregate activity cause rates of job creation and job destruction to move in opposite directions, while changes in the intensity of the reallocation process cause them to move in parallel.

What do we see? Here’s some recent data from the Cleveland Fed:

Overwhelmingly, what we’ve seen is a simultaneous fall in vacancies and rise in unemployment, which tells us that this is an aggregate demand shock.

What about that uptick at the lower right? That worried many people, myself included. But we should have read Blanchard and Diamond more closely: they carefully explain why business cycles tend to produce counterclockwise spirals in the unemployment/vacancies relationship, so this was just what we should have expected.

Deeply relevant work. And by the way, for those of us in the modeling business, Peter Diamond’s work is breathtaking in its elegance — nobody cuts through the complexities with such grace.

A happy day for economic theory.