Inflation and Unemployment in the Long Run

Aleksander Berentsen, Guido Menzio, Randall Wright

American Economic Review · 2011 · Volume 101 · Issue 1

Abstract

We study the long-run relation between money (inflation or interest rates) and unemployment. We document positive relationships between these variables at low frequencies. We develop a framework where money and unemployment are modeled using explicit microfoundations, providing a unified theory to analyze labor and goods markets. We calibrate the model and ask how monetary factors account for labor market behavior. We can account for a sizable fraction of the increase in unemployment rates during the 1970s. We show how it matters whether one uses monetary theory based on the search-and-bargaining approach or on an ad hoc cash-in-advance constraint. (JEL E24, E31, E41, E43, E52)

Keywords

Employment, Unemployment, Wages, Intergenerational Income Distribution, Aggregate Human Capital, Price Level, Inflation, Deflation, Demand for Money, Interest Rates: Determination, Term Structure, and Effects, Monetary Policy

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