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The Role of Shocks and Institutions in the Rise of European Unemployment: The Aggregate Evidence

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  • Olivier Blanchard
  • Justin Wolfers

Abstract

Two key facts about European unemployment must be explained: the rise in unemployment since the 1960s, and the heterogeneity of individual country experiences. While adverse shocks can potentially explain much of the rise in unemployment, there is insufficient heterogeneity in these shocks to explain cross-country differences. Alternatively, while explanations focusing on labor market institutions explain cross-country differences explain current heterogeneity well, many of these institutions pre-date the rise in unemployment. Based on a panel of institutions and shocks for 20 OECD nations since 1960, we find that the interaction between shocks and institutions is crucial to explaining both stylized facts. We test two specifications, and each offers significant support for our interactions hypothesis. The first speculation assumes that there are common but unobservable shocks across countries, and that these shocks have a larger and more persistent effect in countries with poor labor market institutions. The second constructs series for the macro shocks, and again finds evidence that the same size shock has differential effects on unemployment when labor market institutions differ. We interpret this as suggesting that institutions determine the relevance of the unemployed to wage-setting, thereby determining the evolution of equilibrium unemployment rates following a shock.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7282.

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Date of creation: Aug 1999
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Handle: RePEc:nbr:nberwo:7282

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  1. Olivier J. Blanchard & Lawrence H. Summers, 1987. "Hysteresis and the European Unemployment Problem," NBER Working Papers 1950, National Bureau of Economic Research, Inc.
  2. Nickell, S. & Layard, R., 1997. "Labour Market Institutions and Economic Performance," Papers 23, Centre for Economic Performance & Institute of Economics.
  3. Lars Ljungqvist & Thomas J. Sargent, 1998. "The European Unemployment Dilemma," Journal of Political Economy, University of Chicago Press, vol. 106(3), pages 514-550, June.
  4. Dale T. Mortensen & Christopher A. Pissarides, 1999. "Job Reallocation, Employment Fluctuations and Unemployment," CEP Discussion Papers dp0421, Centre for Economic Performance, LSE.
  5. Olivier Blanchard & Pedro Portugal, 1998. "What Hides Behind An Unemployment Rate: Comparing Portuguese and Us Unemployment," Working Papers w199803, Banco de Portugal, Economics and Research Department.
  6. Lazear, Edward P, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, MIT Press, vol. 105(3), pages 699-726, August.
  7. Lindbeck, Assar, 1995. "Hazardous Welfare-State Dynamics," American Economic Review, American Economic Association, vol. 85(2), pages 9-15, May.
  8. Stephen Nickell, 1997. "Unemployment and Labor Market Rigidities: Europe versus North America," Journal of Economic Perspectives, American Economic Association, vol. 11(3), pages 55-74, Summer.
  9. Grubb, David B & Jackman, Richard A & Layard, Richard G, 1982. "Causes of the Current Stagflation," Review of Economic Studies, Wiley Blackwell, vol. 49(5), pages 707-30, Special I.
  10. B Bell & Stephen Nickell, 1996. "Would Cutting Payroll Taxes on the Unskilled Have a Significant Effect on Unemployment?," CEP Discussion Papers dp0276, Centre for Economic Performance, LSE.
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  1. En bra arbetslöshetsförsäkring skapar inte arbetslöshet men ger en bättre matchning på arbetsmarknaden
    by Roger Mörtvik in Utredarna on 2012-09-14 13:51:48
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