QUESTION 12

Question 12

Question 12

For the last twenty years the theory of the natural rate has dominated macroeconomic policy making. Attention has predominantly focused on its implications for the inflation - unemployment trade-off. However, another implication concerns the possibility that policy makers may get caught in a structural unemployment policy trap.

Natural rate theory decomposes unemployment into structural and cyclical components, and it is claimed that the structural component predominates. As a result, counter-cyclical macroeconomic policy is diminished, and policy makers are led to focus on policies of labor market flexibility. This policy stance results in permanently higher aggregate unemployment, and promotes the remaking of labor markets in a fashion ...