Underemployment equilibrium occurs when the rate of unemployment remains persistently low, or "stuck" at a level higher than normal. It is usually either a result of macroeconomic instabilities in the economy, also known as a structural unemployment. Examples of this include when there are too many persons applying for a finite amount of jobs relative to the size of the labour market, or when wages are so low they do not cover the higher cost of living.

In an underemployment equilibrium, aggregate demand falls below full potential output. This results in weak aggregate demand, which leads to further economic difficulties. The prolonged low level of aggregate demand is visible in a range of economic data, such as;

• Wages not keeping up with the cost of living • High levels of income inequality • Low or even negative GDP growth • Low levels of investment • High levels of debt

The Keynesian theory provides a way to explain this phenomenon. According to the theory, when aggregate demand falls and stays below full potential output for some time, firms may cut back their operation, leading to reduced employment and output. As a result, unemployment rates remain persistently high, rather than temporarily and cyclically bouncing up and down, resulting in an underemployment equilibrium.

Many economists now agree that an underemployment equilibrium can lead to an economic malaise that is more difficult to recover from than a regular recession. As the economy remains stuck in a state of weak demand, the associated lack of employment opportunities and lack of wages needed to support oneself, can damage the morale of the local population and bring about a loss of faith in the economy. The 2010-2014 Eurozone crisis offers an example of the effects of an underemployment equilibrium. Greece, in particular, suffered throughout this period, with austerity measures exacerbating the country’s economic problems, and the government adopting measures such as higher taxes on the most vulnerable of citizens alongside wage and pension cuts.

To escape from this situation and return the economy to full capacity, the inherent causes of the underemployment equilibrium must be addressed. Governments should focus, for instance, on reducing inequality, encouraging full employment policies, and fostering positive private sector investment. If successful, this could eventually lead to a return to economic equilibrium with strong economic growth and a more equitable distribution of income, investment and opportunity.