Is it Aggregate demand?

Christina Romer (head of Barack Obama's Council of Economic Advisors) gave a talk on the state of the economy, and particularly on unemployment. She joked that her preferred title for the speech, which she didn't end up using, was "It's the aggregate demand, stupid". Her argument is that the reason unemployment remains high is the persistent shortfall in aggregate demand. Structural factors are not important:

The high unemployment that the United States is experiencing reflects a severe shortfall of aggregate demand. Despite three quarters of growth, real GDP is approximately 6 percent below its trend path. Unemployment is high fundamentally because the economy is producing dramatically below its capacity. That is, far from being “the new normal,” it is “the old cyclical.”...

Many have suggested that the fact that long-term unemployment is at record levels is a sign that the high unemployment rate is the result of structural factors. There are now 6½ million workers who have been unemployed for more than 26 weeks, and these workers represent a record 44 percent of the unemployed. Long-term unemployment is cause for serious concern. Long spells of unemployment cause much greater hardship than short spells, and they can be associated with deterioration of skills and long-term falls in earnings.

But, this rise in long-term unemployment is readily explained by the prolonged collapse of aggregate demand. When hiring rates are very depressed, workers who lose their jobs are unlikely to find work quickly, and thus face a substantial chance of becoming long-term unemployed. This effect is compounded by the fact that exit rates from unemployment, both in normal times and in recessions, are typically lower the longer a worker has been unemployed. This makes it even more likely that those who do not find work quickly will have long spells of unemployment. Thus, the rise in long-term unemployment is the almost-inevitable consequence of the severe recession. We do not need to appeal to any underlying structural changes to understand it, and there is every reason to expect that long-term unemployment will come back down when aggregate demand recovers.

Other observers point to troubling trends, such as the decline in traditional manufacturing jobs and falling rates of employment among less educated middle-aged men, as signs of the inevitability of permanently high unemployment. These developments have led to terrible distress in some communities and devastation for the workers affected. But, these trends were in full sway in the 1990s and mid-2000s, when the unemployment rate fell to very low levels. They are trends that we absolutely need to work to change, but they are not indications that the United States is doomed to permanently higher unemployment.

Another concern is that certain sectors, notably construction and finance, are likely to remain substantially smaller than they were during the boom even after the economy returns to normal. As a result, some observers have suggested that the workers who lost their jobs in these sectors may have trouble finding work after the economy recovers—and thus that reallocations across sectors might mean higher unemployment in the long run. In fact, however, we have seen only slight declines in the rate at which workers who have lost their jobs in declining sectors exit unemployment relative to workers who lost jobs in other sectors. The dominant pattern is that workers from all sectors have seen their exit rates fall, exactly as one would expect when job creation is low.

What are your views on this speech? Leave your comments.