Hysteresis in unemployment: Evidence from 23 OECD countries

Abstract

Unemployment is one of the most important problems that all countries must overcome. As a result, it has become one of the centrally explored issues in macroeconomics, and several theories have been proposed to explain the existence of high unemployment rates. Traditional theories describe movements of unemployment as fluctuations around a natural rate. However, theories that rely on a natural rate of unemployment have been challenged by hysteresis theories. According to hysteresis theories, all shocks have permanent effects on the level of unemployment. This paper tests hysteresis effects in unemployment using panel data for 23 OECD countries covering the period 1963 - 2007. The paper applies both a univariate time series and a panel data unit root test with and without a structural break to test for unemployment hysteresis in OECD countries against the alternative of a natural rate. The results point to the rejection of the hysteresis hypothesis for the OECD and are compatible with structuralist theories as described by the structuralist view.