Would Keynesian Expansionary Policies Eliminate the Natural Rate of Unemployment: Insights from The Sri Lankan Economy

This paper develops a Keynesian stochastic framework to reassess the natural rate hypothesis in the context of the Sri Lankan economy. By embedding fractional Brownian motion to capture persistent inflationary shocks and incorporating nonlinear interactions between unemployment dynamics and aggregate demand, the model contrasts expansionary Keynesian policies with the monetarist view of structural unemployment. Empirically, the estimated income series indicates that targeted income interventions can systematically reduce unemployment over time, illustrating the capacity of demand-side policies to stabilize labor markets. The results suggest that fiscal and monetary measures, when sustained and coordinated, not only mitigate hysteresis effects but can also shift unemployment away from the so-called natural level, reaffirming the Keynesian insight that active policy can shape real economic outcomes even in the presence of structural frictions. This study contributes both theoretically to macroeconomic stabilization debates and practically to policy design in economies facing recurrent shocks and structural vulnerabilities. JEL Classification. E24, E32, E62, O53