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How "Natural" is the Natural Rate? Unemployment Hysteresis in Iceland

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  • Bjarni G. Einarsson
  • Jósef Sigurdsson

Abstract

This paper estimates the Non-Accelerating Inflation Rate of Unemployment (the NAIRU) for Iceland based on the Phillips curve using an iterative regression process and the Kalman filter. According to our results, the NAIRU rose sharply in the wake of the financial crisis, peaking at 5½% or 7% depending on estimation methodology. We evaluate what factors influence changes in the NAIRU. In particular, we assess whether changes in the NAIRU have been influenced by structural changes or changes in actual unemployment and therefore aggregate demand; i.e., whether there is evidence of hysteresis in unemployment. We find that time variation in the NAIRU is to a large extent due to hysteresis effects but to a lesser extent due to structural factors. This implies that monetary policy can have long-run effects on unemployment and its conduct is thus more complicated. Prudence in the government’s conduct of fiscal policy and labor unions’ and their counterparties’ wage bargaining becomes more important in the presence of hysteresis in unemployment, as inflationary pressures must be countered with a rise in interest rates, which can cause an increase in the NAIRU. Keeping inflation low becomes more important for the real economy in the presence of hysteresis in unemployment.

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Bibliographic Info

Paper provided by Department of Economics, Central bank of Iceland in its series Economics with number wp64.

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Date of creation: Jul 2013
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Handle: RePEc:ice:wpaper:wp64

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  1. Robert J. Gordon, 1996. "The Time-Varying NAIRU and its Implications for Economic Policy," NBER Working Papers 5735, National Bureau of Economic Research, Inc.
  2. Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780199279173, Octomber.
  3. Aizenman, Joshua & Pinto, Brian & Sushko, Vladyslav, 2013. "Financial sector ups and downs and the real sector in the open economy: Up by the stairs, down by the parachute," Emerging Markets Review, Elsevier, vol. 16(C), pages 1-30.
  4. Stéphanie Guichard & Elena Rusticelli, 2010. "Assessing the Impact of the Financial Crisis on Structural Unemployment in OECD Countries," OECD Economics Department Working Papers 767, OECD Publishing.
  5. Card, David & Kluve, Jochen & Weber, Andrea, 2009. "Active Labor Market Policy Evaluations: A Meta-Analysis," IZA Discussion Papers 4002, Institute for the Study of Labor (IZA).
  6. Llaudes, Ricardo, 2005. "The Phillips curve and long-term unemployment," Working Paper Series 0441, European Central Bank.
  7. Stéphanie Guichard & Elena Rusticelli, 2011. "Reassessing the NAIRUs after the Crisis," OECD Economics Department Working Papers 918, OECD Publishing.
  8. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis And The European Unemployment Problem," NBER Chapters, in: NBER Macroeconomics Annual 1986, Volume 1, pages 15-90 National Bureau of Economic Research, Inc.
  9. Christian Gianella & Isabell Koske & Elena Rusticelli & Olivier Chatal, 2008. "What Drives the NAIRU? Evidence from a Panel of OECD Countries," OECD Economics Department Working Papers 649, OECD Publishing.
  10. Laurence Ball & N. Gregory Mankiw, 2002. "The NAIRU in Theory and Practice," NBER Working Papers 8940, National Bureau of Economic Research, Inc.
  11. Laurence M. Ball, 2009. "Hysteresis in Unemployment: Old and New Evidence," NBER Working Papers 14818, National Bureau of Economic Research, Inc.
  12. Jósef Sigurdsson, 2011. "Unemployment Dynamics and Cyclical Fluctuations in the Icelandic Labour Market," Economics wp56, Department of Economics, Central bank of Iceland.
  13. Ellis, C.J. & Holden, S., 1991. "Hysteresis and the Seniority-Wage Relationship," Memorandum 09/1991, Oslo University, Department of Economics.
  14. Bjarni G. Einarsson & Gudjón Emilsson & Svava J. Haraldsdóttir & Thórarinn G. Pétursson & Rósa B. Sveinsdóttir, 2013. "On our own? The Icelandic business cycle in an international context," Economics wp63, Department of Economics, Central bank of Iceland.
  15. Jaeger, Albert & Parkinson, Martin, 1994. "Some evidence on hysteresis in unemployment rates," European Economic Review, Elsevier, vol. 38(2), pages 329-342, February.
  16. Alan B. Krueger & Andreas Mueller, 2011. "Job Search, Emotional Well-Being and Job Finding in a Period of Mass Unemployment: Evidence from High-Frequency Longitudinal Data," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(1 (Spring), pages 1-81.
  17. Pete Richardson & Laurence Boone & Claude Giorno & Mara Meacci & David Rae & David Turner, 2000. "The Concept, Policy Use and Measurement of Structural Unemployment: Estimating a Time Varying NAIRU Across 21 OECD Countries," OECD Economics Department Working Papers 250, OECD Publishing.
  18. Thomas Laubach, 1997. "Measuring the NAIRU : evidence from seven economies," Research Working Paper 97-13, Federal Reserve Bank of Kansas City.
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