Time-varying equilibrium rates of unemployment: an analysis with Australian data

We explore a new approach to understanding the evolution of the unemployment rate in Australia. Specifically, we use gross worker flows data to study the consequences of assuming that there is no unique equilibrium rate of unemployment but rather a continuum of stochastic equilibrium rates which reflect the movement of the unemployment entry and exit rates over time. The stochastic equilibrium unemployment rate and the observed unemployment rate are very closely related and we explore the reasons why this is so. We then examine the short-run dynamics of the entry and exit rates (specifically, the impulse response functions) and the impact of shocks to the entry and exit rates on the unemployment rate. We find that shocks to the entry rate have been more important than shocks to the exit rate in bringing about variations in the unemployment rate over our sample period. Finally, we present a new way to disentangle the effects of the business cycle from the effects of structural shifts on the (equilibrium) unemployment rate. It would appear that there was a once and for all downward shift in the equilibrium rate(s) of unemployment in Australia in the early 1990s, which likely reflects the introduction of a more generous system of disability pension benefits.