Lecture 3: Empirical evidence on unemployment

The issues

• View #1: Unemployment is the result of cumulated shocks of various nature and persistence

• View #2: Unemployment is a structural phenomenon due to labor market rigidities, as in the models we have seen

Blanchard-Wolfers

• Unemployment has increase in most European countries since 1975

• It was very low before

• And there is an increased dispersion across European countries

The puzzle:

• Shocks-based explanations do not explain the dispersion – Oil shocks and macro conditions too similar

across countries

• Institutions-based explanations fail to account for the fact that unemployment was low while these institutions were still around

The solution

• Shocks interact with institutions

• Some institutions are harmless absent shocks

• But they can increase the magnitude of the unemployment response to the shock

• And they can increase the persistence of the shock

The Pro: it’s plausible

• Coordination in bargaining better response of wages to a productivity slowdown

• High duration of benefits More of LTU during a recessionMore persistence of a shock (as seen)

The Con:

• Hard to think of an institution which does not also increase the natural rate.

• More coordination less negative externalities in wage-settinglower markup of wages on prices less unemployment

• Longer benefitslower search intensity and greater worker outside option more unemployment

The shocks: the medium run

• A slowdown in TFP growth (why does it affect u?)

• An increase in the real interest rate (same question)

• An unexplained and poorly documented fall in labor demand…

TFP:

Real interest rate:

Institutions (their view)

• UB : Higher unemployment and higher duration

• EPL: Higher duration, lower inflows, ambiguous effect on employment

• Taxes: lower wages, lower employment, but little effect on unemployment if « aspirations » adjust proportionally to after-tax wages

Interactions: Specification #1

• We use institutions to explain the change in unemployment rather than its level

• We use a panel and assume the effect is the same across countries

• This leads to the following specification (i = country, j = institution)

Interactions: specification #2

• The time dummy is replaced by a vector of country-specific shock

• The effect of shocks depends on institutions

• But a given institution has the same effect on all shocks

Assessment:

• It is hard to see why institutions could not matter on their own

• The authors present no institutions-only exercise

• If onlys S*I matters, unemployment should go away as shocks are reversed

• Alternative possibility: multiple equilibrium rates of unemployment