Labor Force Participation and Monetary Policy in the Wake of the Great Recession

Abstract

In this paper, we provide compelling evidence that cyclical factors account for the bulk of thepost-2007 decline in the U.S. labor force participation rate. We then proceed to formulate astylized New Keynesian model in which labor force participation is essentially acyclical during“normal times” (that is, in response to small or transitory shocks) but drops markedly in the wakeof a large and persistent aggregate demand shock. Finally, we show that these considerations canhave potentially crucial implications for the design of monetary policy, especially undercircumstances in which adjustments to the short-term interest rate are constrained by the zerolower bound.