“...at present the situation is different. The risks of ‘doing too little’—i.e. that cyclical unemployment becomes structural—outweigh those of ‘doing too much’—that is, excessive upward wage and price pressures.”
Mario Mario Draghi (2014), President of the ECB, Jackson Hole Speech.
Abstract
We examine the unemployment hysteresis hypothesis for 31 European countries, the USA and Japan, using alternative linear and nonlinear unit root tests, taking into account possible structural breaks. Two types of smooth transition models—Exponential Smooth Transition Autoregressive and Asymmetric Exponential Smooth Transition Autoregressive—are employed to account for the nonlinear mean-reverting behaviour in unemployment due to heterogeneity in hiring and firing costs across firms. Four main results emerge: first, the hysteresis hypothesis is rejected for 60 % of the countries in our sample. Second, nonlinear models capture the asymmetries in unemployment dynamics over the business cycle for some countries. Third, many of the series display multiple structural breaks which might point out shifts in mean level of unemployment. Fourth, forecasting powers of our nonlinear models display poor performance against the linear AR specification. The results have policy implications for the debate on the benefits of demand or supply-side policies for tackling the current unemployment problem in Europe.
Similar content being viewed by others
Notes
Blanchard and Summers (1986) point out asymmetries in wage setting process between insiders and outsiders as the main driver of a propagation mechanism in unemployment. They argue that negative shocks contracting number of workers could increase the bargaining power of insiders due to their increasing marginal product. This would lead to a new equilibrium wage rate. This line of reasoning is later critisized in Lindbeck and Snower (2001) which argues that the remaining insiders are not necessarily more secure because in case of negative shocks (i) firms might decide to contract capital and labour services simultaneously provided that they have excess capacity and (ii) the relation between the wage negotiation and employment is not unambiguous due to changes in reservation wage.
In general, short-term demand shocks are considered to have cyclical impacts on unemployment while supply shocks might lead to long-term changes in labour market conditions.
Obviously, as Bean (1997) argues, a “fine tuning” is almost impossible due to high level of uncertainty regarding the economy. However, offsetting policy actions would lead to a “coarse tune” of the economy by means of smoothing the economic activity.
In a similar manner, Yellen (2012) motivates a loose monetary policy stance with FED’s concerns over hysteresis: “To date, I have not seen evidence that hysteresis is occurring to any substantial degree... Nonetheless, the risk that continued high unemployment could eventually lead to more-persistent structural problems underscores the case for maintaining a highly accommodative stance of monetary policy.”
Another reason for unemployment persistence could be the stigmatization of unemployed workers (Blanchard and Diamond 1994).
Blanchard and Summers (1986) also favour a looser form of the definition where coefficients do not add up to one but very close to one (a near unit root process). These two cases are also referred later in the literature as pure hysteresis or partial hysteresis (see Layard et al. 1991; León-Ledesma and McAdam 2004). In this study, the hysteresis term is used to refer to the case where the autoregressive parameter is unity (i.e. a unit root process or pure hysteresis).
Phelps and Zoega (1998) point out other structural factors behind unemployment such as technological change, labour productivity or educational composition of the labour force.
Davis and Haltiwanger (1991) show that job destruction and job creation by US firms display heterogeneity for both cross-sectional and time dimensions for US firms. They argue that job destruction is relatively more volatile over the business cycle and job reallocation displays a countercyclical movement.
Moreover, these causes could be a result of government policies such as compulsory advance notice of layoffs or changes in the financing structure of unemployment compensation dynamics (Hamermesh and Pfann 1996).
In a recent study, Galí (2016) analyses the implications of this framework on optimal monetary policy design.
Recently, Cheng et al. (2014) employs flexible Fourier unit root test; Caporale and Gil-Alana (2007) and Cuestas et al. (2011) use fractional integration along with nonlinear techniques; Pérez-Alonso and Di Sanzo (2011) propose a nonlinear unobserved component model to test for hysteresis. Cuestas and Ordóñez (2011) explore the nonlinearities in unemployment rates of Central and Eastern European countries with ESTAR and LSTAR models. Gustavsson and Österholm (2006) also employ ESTAR model for testing the unemployment hysteresis for five developed countries. Bolat et al. (2014) apply nonlinear panel unit root tests for the Eurozone area.
Later on, Lumsdaine and Papell (1997) extend this methodology with two structural breakpoints alternative, emphasizing that the unit-root test results are sensitive to the number of breaks in the alternative hypothesis.
This correction behaviour could also be motivated as a reflection of the business cycles. A long-run mean reversion would imply that recessions will be followed by a recovery which could be the result of an improvement in expectations, corresponding to a positive demand shock in Bentolila and Bertola (1990). An ESTAR-type adjustment imposes that these countercyclical movements that would move the unemployment level back to equilibrium are not that strong when the series is close to its mean but gets stronger when it gets far away from it. Also, note that employment is a nonstationary process in Bentolila and Bertola (1990) since they conduct their analysis for a given level of demand in order to examine the comparative dynamics. Instead, our study focuses on long-term time series characteristics of unemployment, i.e. considering alternative phases of the cycle, testing the presence of a long-run mean reversion.
The \({B}_\mathrm{L }\) level could also move depending on the magnitude of the impact of the change in severance payments on the threshold levels \({B}_\mathrm{LL}\) or \({B}_{\mathrm{LL'}}\) in the lower regions.
For the current period, the source of the differences requires an in-depth analysis for the individual countries, which is beyond the scope of this exercise and stands as a good research question for the future.
Hence, we only present the estimation results for AESTAR model in this section. The ESTAR estimation results are not presented due to space considerations but are available upon request.
The nonlinear problem is solved by the sequential quadratic programming method of Gauss 14. The estimation returns the smallest value to fulfil with the restrictions for some parameters. Standard errors are very close to zero for these cases.
For time-inconsistency and resulting free-rider problems in a monetary union that would negatively affect the structural reform incentives, see Chari and Kehoe (2008).
For the impacts of economic governance of Europe on European labour markets, see Ioannou and Stracca (2014).
References
Akdoğan K (2014) Asymmetric behaviour of inflation around the target in inflation-targeting countries. Scott J Polit Econ 62(5):486–504
Altavilla C, De Grauwe P (2010) Forecasting and combining competing models of exchange rate determination. Appl Econ 42(27):3455–3480
Arestis P, Mariscal IBF (1998) Capital shortages and asymmetries in UK unemployment. Struct Change Econ Dyn 9(2):189–204
Ayala A, Cuñado J, Gil-Alana LA (2012) Unemployment hysteresis: empirical evidence for Latin America. J Appl Econ 15(2):213–233
Bean C (1997) The role of demand-management policies in reducing unemployment. Government options for the labour market, Unemployment policy, pp 83–111
Bean C, Mayer C (1989) Capital shortages and persistent unemployment. Econ Policy 4(8):11–53
Beetsma R, Giuliodori M (2010) The macroeconomic costs and benefits of the EMU and other monetary unions: an overview of recent research. J Econ lit 48(3):603–641
Bentolila S, Bertola G (1990) Firing costs and labour demand: how bad is eurosclerosis? Rev Econ Stud 57(3):381–402
Bianchi M, Zoega G (1998) Unemployment persistence: does the size of the shock matter? J Appl Econom 13(3):283–304
Blanchard O (2006) European unemployment: the evolution of facts and ideas. Econ Policy 21(45):6–59
Blanchard OJ, Summers LH (1986) Hysteresis and the European unemployment problem. In: NBER macroeconomics annual 1986, vol 1. MIT Press, pp 15–90
Blanchard OJ, Diamond P (1994) Ranking, unemployment duration, and wages. Rev Econ Stud 61(3):417–434
Bolat S, Tiwari AK, Erdayi AU (2014) Unemployment hysteresis in the Eurozone area: evidences from nonlinear heterogeneous panel unit root tests. Appl Econ Lett 21(8):536–540
Caballero RJ, Hammour ML (1991) The cleansing effect of recessions. National Bureau of Economic, Research w3922
Calmfors L (2001) Unemployment, labour market reform, and monetary union. J Labor Econ 19(2):265–289
Caner M, Hansen BE (2001) Threshold autoregression with a unit root. Econometrica 69(6):1555–1596
Caporale GM, Gil-Alana LA (2007) Nonlinearities and fractional integration in the US unemployment rate. Oxf Bull Econ Stat 69(4):521–544
Chari VV, Kehoe PJ (2008) Time inconsistency and free-riding in a monetary union. J Money Credit Bank 40(7):1329–1356
Cheng SC, Wu TP, Lee KC, Chang T (2014) Flexible Fourier unit root test of unemployment for PIIGS countries. Econ Model 36:142–148
Christopoulos DK, León-Ledesma MA (2010) Smooth breaks and non-linear mean reversion: Post-Bretton Woods real exchange rates. J Int Money Finance 29(6):1076–1093
Clements MP, Smith J (2001) Evaluating forecasts from SETAR models of exchange rates. J Int Money Finance 20(1):133–148
Coakley J, Fuertes AM, Zoega G (2001) Evaluating the persistence and structuralist theories of unemployment from a nonlinear perspective. Stud Nonlinear Dyn Econom 5(3):179–202
Cuestas JC, Ordóñez J (2011) Unemployment and common smooth transition trends in Central and Eastern European Countries. Econ Issues 16(2):39
Cuestas JC, Gil-Alana LA, Staehr K (2011) A further investigation of unemployment persistence in European transition economies. J Comp Econ 39(4):514–532
Davis SJ, Haltiwanger J (1991) Gross job creation, gross job destruction and employment reallocation. National Bureau of Economic, Research w3728
Draghi M (2014) Unemployment in the euro area. Speech in annual central bank symposium in Jackson Hole, 22 August 2014. www.ecb.eu
Enders W, Granger CWJ (1998) Unit-root tests and asymmetric adjustment with an example using the term structure of interest rates. J Bus Econ Stat 16(3):304–311
European Commission (2013) Labour market developments in Europe. European Economy, 6/2013
Ferrara L, Marcellino M, Mogliani M (2015) Macroeconomic forecasting during the Great Recession: the return of non-linearity? Int J Forecast 31(3):664–679
Fosten J, Ghoshray A (2011) Dynamic persistence in the unemployment rate of OECD countries. Econ Model 28(3):948–954
Galí J (2016) Insider-outsider labor markets, hysteresis and monetary policy, unpublished manuscript
Granger CWJ, Teräsvirta T (1993) Modelling nonlinear economic relationships. Oxford University Press, Oxford
Gustavsson M, Österholm P (2006) Hysteresis and non-linearities in unemployment rates. Appl Econ Lett 13(9):545–548
Hamermesh DS, Pfann GA (1996) Adjustment costs in factor demand. J Econ Lit 34(3):1264–1292
Hansen BE (1997) Inference in TAR models. Stud Nonlinear Dyn Econom 2(1):1–14
Ioannou D, Stracca L (2014) Have the euro area and EU governance worked? Just the facts. Eur J Polit Econ 34:1–17
Jaeger A, Parkinson M (1994) Some evidence on hysteresis in unemployment rates. Eur Econ Rev 38(2):329–342
Kapetanios G, Shin Y, Snell A (2003) Testing for a unit root in the nonlinear STAR framework. J Econom 112(2):359–379
Karanassou M, Sala H, Snower DJ (2010) Phillips curves and unemployment dynamics: a critique and a holistic perspective. J Econ Surv 24(1):1–51
Kilian L, Taylor MP (2003) Why is it so difficult to beat the random walk forecast of exchange rates? J Int Econ 60(1):85–107
Kim D, Perron P (2009) Unit root tests allowing for a break in the trend function at an unknown time under both the null and alternative hypotheses. J Econom 148(1):1–13
Koop G, Potter SM (1999) Dynamic asymmetries in US unemployment. J Bus Econ Stat 17(3):298–312
Lanzafame M (2010) The nature of regional unemployment in Italy. Empir Econ 39(3):877–895
Layard R, Nickell SJ, Jackman R (1991) Unemployment: macroeconomic performance and the labour market. Oxford University Press, Oxford
Lee J, Strazicich MC (2003) Minimum Lagrange multiplier unit root test with two structural breaks. Rev Econ Stat 85(4):1082–1089
Lee J, Strazicich MC (2004) Minimum LM unit root test with one structural break. Manuscript, Department of Economics, Appalachian State University, Boone
Lee CC, Chang CP (2008) Unemployment hysteresis in OECD countries: Centurial time series evidence with structural breaks. Econ Model 25(2):312–325
Lee JD, Lee CC, Chang CP (2009) Hysteresis in unemployment revisited: evidence from panel LM unit root tests with heterogeneous structural breaks. Bull Econ Res 61(4):325–334
León-Ledesma MA, McAdam P (2004) Unemployment, hysteresis and transition. Scott J Polit Econ 51(3):377–401
Lindbeck A, Snower DJ (2001) Insiders versus outsiders. J Econ Perspect 78(1):165–188
Lumsdaine RL, Papell DH (1997) Multiple trend breaks and the unit-root hypothesis. Rev Econ Stat 79(2):212–218
Matthews K, Minford P, Naraidoo R (2008) Vicious and virtuous circles—the political economy of unemployment in interwar UK and USA. Eur J Polit Econ 24(3):605–614
McMillan DG, Wohar ME (2010) Stock return predictability and dividend-price ratio: a nonlinear approach. Int J Finance Econ 15(4):351–365
Mortensen DT (1989) The persistence and indeterminacy of unemployment in search equilibrium. Scand J Econ 91(2):347–370
Neftci SN (1984) Are economic time series asymmetric over the business cycle? J Polit Econ 92(2):307–328
Pérez-Alonso A, Di Sanzo S (2011) Unemployment and hysteresis: a nonlinear unobserved components approach. Stud Nonlinear Dyn Econom 15(1):1–27
Perron P (1989) The great crash, the oil price shock, and the unit root hypothesis. Econom J Econom Soc 57(6):1361–1401
Pesaran H, Timmermann A (1999) Model instability and choice of observation window. UC San Diego Department of Economics, Discussion Papers. pp 1–60
Phelps ES (1967) Phillips curves, expectations of inflation and optimal unemployment over time. Economica 34:254–81
Phelps ES (1968) Money-wage dynamics and labour market equilibrium. J Polit Econ 76:678–711
Phelps ES (1994) Structural slumps: the modern equilibrium theory of unemployment, interests and assets. Harvard University Press, Cambridge
Phelps ES, Zoega G (1998) Natural-rate theory and OECD unemployment. Econ J 108(448):782–801
Raurich X, Sala H, Sorolla V (2006) Unemployment, growth, and fiscal policy: new insights on the hysteresis hypothesis. Macroecon Dyn 10(03):285–316
Røed K (1997) Hysteresis in unemployment. J Econ Surv 11(4):389–418
Sibert A, Sutherland A (2000) Monetary union and labour market reform. J Int Econ 51(2):421–435
Skalin J, Teräsvirta T (2002) Modeling asymmetries and moving equilibria in unemployment rates. Macroecon Dyn 6(02):202–241
Sollis R (2009) A simple unit root test against asymmetric STAR nonlinearity with an application to real exchange rates in Nordic countries. Econ Model 26(1):118–125
Strazicich MC, Lee J, Day E (2004) Are incomes converging among OECD countries? Time series evidence with two structural breaks. J Macroecon 26(1):131–145
Teräsvirta T (1994) Specification, estimation, and evaluation of smooth transition autoregressive models. J Am Stat Assoc 89(425):208–218
Teräsvirta T (2006) Forecasting economic variables with nonlinear models. In: Handbook of economic forecasting. pp 413–457
Teräsvirta T, Anderson HM (1992) Characterizing nonlinearities in business cycles using smooth transition autoregressive models. J Appl Econom 7(S1):S119–S136
Teräsvirta T, Van Dijk D, Medeiros MC (2005) Linear models, smooth transition autoregressions, and neural networks for forecasting macroeconomic time series: A re-examination. Int J Forecast 21(4):755–774
Tong H (1990) Nonlinear time series: a dynamical system approach. Clarendon Press, Oxford
Yellen J (2012) The economic outlook and monetary policy. Speech. At the Money Marketeers of New York University, New York, April 11, 2012. www.federalreserve.gov
Zivot E, Andrews DWK (2002) Further evidence on the great crash, the oil-price shock, and the unit-root hypothesis. J Bus Econ Stat 20(1):25–44
Author information
Authors and Affiliations
Corresponding author
Additional information
The views and opinions presented in this study belong to the author and do not necessarily represent those of the Central Bank of the Republic of Turkey or its staff.
Rights and permissions
About this article
Cite this article
Akdoğan, K. Unemployment hysteresis and structural change in Europe. Empir Econ 53, 1415–1440 (2017). https://doi.org/10.1007/s00181-016-1171-8
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s00181-016-1171-8