Unemployment dynamics : the chain reaction theory

• Main Author: Karanassou, Maria
• Published: Birkbeck (University of London) 1998
• Subjects: 330; Labour market dynamics
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.481508

The aim of the thesis is to examine, mainly, how labour market dynamics affect unemployment. We consider labour market models where current decisions - regarding employment, wage setting, and labour supply behaviour - depend on past decisions, and where these lagged adjustment processes interact. These interactions are the centerpiece of the chain reaction theory of unemployment, in which each labour market shock has a chain reaction of unemployment effects. Chapter 1 analyzes two important dynamic influences: (i) the prolonged effects of temporary shocks, called unemployment persistence, and (ii) the delayed effects of permanent shocks, which we call imperfect unemployment responsiveness. Focusing on three countries - Germany, UK, and US - we identify significant labour market lags, and measure the degree to which these lags are responsible for unemployment persistence and imperfect responsiveness. Chapter 2 shows that in multi-equation labour market models containing lagged endogenous variables and exogenous variables with nonzero long-run growth rates the natural rate of unemployment - as conventionally defined for empirical purposes - is not a reference point (a value toward which the equilibrium unemployment rate tends with the passage of time). Chapter 3 evaluates the natural rate and chain reaction theories of unemployment. For an empirical model of the UK labour market, we show that un-employment does not converge to the natural rate, as conventionally defined. Furthermore, we show that the labour market lags account for a substantial part of the UK long-run equilibrium unemployment rate as well as for the movement of UK unemployment over the past one and a half decades. Chapter 4 shows that real inertia (sluggish adjustment of real variables) may have a powerful role to play in generating the real effects of nominal (demand) shocks, and nominal inertia (sluggish adjustment of nominal wages and prices) may be important in propagating real (supply-side) shocks.