Is Unemployment on Steroids in Advanced Economies?

34 Pages Posted: 22 Aug 2018

See all articles by C. Gabriel Di Bella

C. Gabriel Di Bella

International Monetary Fund (IMF)

Francesco Grigoli

International Monetary Fund (IMF)

Francisco Ramirez de Leon

Central Bank of the Dominican Republic

Date Written: July 2018

Abstract

Despite conventional macroeconomic theory is based on the idea that demand shocks can only have temporary effects on unemployment, several European economies display highly persistent unemployment dynamics. The theory of hysteresis challenges this view and pointsout that, under certain conditions, demand disturbances can have permanent effects. In this paper, we find strong empirical evidence of unemployment hysteresis in advanced economies since the 1990s. Relying on an identification scheme instigated by an insider/outsider model, we study the effects of demand shocks allowing for cross-country heterogeneous dynamics, and exploit such heterogeneity to investigate what institutional settings have the potential to soften or amplify the effects of demand shocks. Our results indicate that strengthening labor market institutions that promote a faster adjustment of real wages, removing disincentivesfor firms to hire and for workers to be employed, and improving the matching between labor supply and labor demand can lessen the effects of adverse demand shocks and lead to a faster reversion of unemployment rates to pre-shock levels.

Keywords: Unemployment, Advanced economies, hysteresis, panel VAR, persistence, unit root

JEL Classification: E24, E31, E32

Suggested Citation

Di Bella, C. Gabriel and Grigoli, Francesco and Ramirez de Leon, Francisco, Is Unemployment on Steroids in Advanced Economies? (July 2018). IMF Working Paper No. 18/169. Available at SSRN: https://ssrn.com/abstract=3236784

C. Gabriel Di Bella (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Francesco Grigoli

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Francisco Ramirez de Leon

Central Bank of the Dominican Republic ( email )

Post Office Box 1347, Calle Pedro Henríquez Ureña
esq. Leopoldo Navarro
Santo Domingo
Dominican Republic

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