Labour Economics
German unemployment

Unemployment is often thought to return to a stable equilibrium or `natural' rate after shocks, whose future effects are therefore finite. Recent empirical studies of unemployment time-series have demonstrated, however, that such shocks can have an impact over the infinite future, which profoundly challenges standard Keynesian and classical macroeconomics. With new models that consider `persistence' effects of a reduced capital stock following a fall in employment, depreciation effects on human capital or the role of unions, traditional policy recommendations no longer apply. The statistical methods used in such studies do not allow for shocks with long-run, finite impacts, however, so they may accept persistence erroneously if adjustment is slow.

In Discussion Paper No. 739, Rolf Tschernig and Programme Director Klaus F Zimmermann develop a time-series model to generalize these procedures that can also model the finite but long-run effects of shocks on unemployment. They apply this model to seasonally-adjusted, quarterly data to determine whether German unemployment exhibits persistence, what the adjustment path of a single shock looks like, and whether unemployment returns to its equilibrium rate after a shock. Their results reject persistence, but long-run effects are important; shocks reach peak impact after five quarters, and there is weak evidence of a stable natural rate of unemployment. Its persistence in Germany is therefore illusive and reflects inadequate statistical treatment of the data. Adjustment towards equilibrium is slow, so policy should take account of the long-run impact of a single shock, and this may also apply to other European countries. Tschernig and Zimmermann conclude that new economic theories that can explain a history-dependent natural rate of unemployment can therefore account for unemployment's slow adjustment to stable equilibria.

Illusive Persistence in German Unemployment
Rolf Tschernig and Klaus F Zimmermann

Discussion Paper No. 739, November 1992 (HR)