Structural unemployment, underemployment, and secular stagnation

In this paper, we show that underemployment and not necessarily high unemployment becomes the main measure of economic slack in the labor market under secular stagnation. Specifically, involuntary underemployment in the form of a persistent shortfall of working hours occurs in the search and matching model, provided that households derive utility from holding wealth, and quickly dominates the total employment gap under stagnation. Conventional policy measures aimed at reducing unemployment may increase the labor market gap through their effects on underemployment and should be used with caution. In contrast, increases in aggregate demand improve unemployment and working hours, while increases in labor productivity worsen underemployment without improving unemployment (“paradox of toil”). Our analysis provides new insights into empirical puzzles such as Japan's seemingly decent employment record during its lost decades.