There is a growing realization that the dominant theory of unemployment, the natural rate theory, has difficulty accounting for the European unemployment experience of the 1980s. According to this theory, unemployment can be decomposed into two separate, largely independent, components: the natural rate of unemployment and cyclical variations of unemployment around this natural rate. In Discussion Paper No. 1176, Programme Director Dennis Snower and Marika Karanassou take a different approach. They view movements in unemployment as the outcome of: first, how various lags in labour market behaviour interact with one another; and second, how these lags interact with labour market shocks containing temporary and permanent components.

The paper recognizes two dimensions of the unemployment problem: first, the persistent effects of temporary labour market shocks; and second, the delayed effects of permanent shocks. The first is called `unemployment persistence'; the second, `imperfect unemployment responsiveness'. Focusing on three countries – Germany, the UK and the US – the paper identifies important lags in labour demand, wage setting, and labour force participation behaviour, and measures the degree to which these lags are responsible for unemployment persistence and imperfect responsiveness. The empirical analysis shows first that countries displaying a comparatively high degree of unemployment persistence need not necessarily display a comparatively high degree of unemployment under-responsiveness as well. Second, the analysis indicates that within a particular country, different labour market lags have quite different effects on unemployment persistence and imperfect responsiveness. Finally, the analysis shows that a particular lagged effect can have quite different implications for unemployment dynamics in different countries.

A Contribution to Unemployment Dynamics
Dennis J Snower and Marika Karanassou

Discussion Paper No. 1176, May 1995 (HR)