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

Author

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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.

Suggested Citation

  • Bjarni G. Einarsson & Jósef Sigurdsson, 2013. "How "Natural" is the Natural Rate? Unemployment Hysteresis in Iceland," Economics wp64, Department of Economics, Central bank of Iceland.
  • Handle: RePEc:ice:wpaper:wp64
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    File URL: http://www.cb.is/library/Skr%C3%A1arsafn---EN/Research/Working%20Paper%20No%2064.pdf
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    References listed on IDEAS

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    1. 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.
    2. David Card & Jochen Kluve & Andrea Weber, 2010. "Active Labour Market Policy Evaluations: A Meta-Analysis," Economic Journal, Royal Economic Society, vol. 120(548), pages 452-477, November.
    3. Robert J. Gordon, 1997. "The Time-Varying NAIRU and Its Implications for Economic Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 11-32, Winter.
    4. Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780199279173, June.
    5. Laurence Ball & N. Gregory Mankiw, 2002. "The NAIRU in Theory and Practice," Journal of Economic Perspectives, American Economic Association, vol. 16(4), pages 115-136, Fall.
    6. Thomas Laubach, 2001. "Measuring The NAIRU: Evidence From Seven Economies," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 218-231, May.
    7. 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.
    8. repec:oup:oxecpp:v:69:y:2017:i:3:p:655-677. is not listed on IDEAS
    9. 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.
    10. Ellis, C.J. & Holden, S., 1991. "Hysteresis and the Seniority-Wage Relationship," Memorandum 09/1991, Oslo University, Department of Economics.
    11. Stéphanie Guichard & Elena Rusticelli, 2011. "Reassessing the NAIRUs after the Crisis," OECD Economics Department Working Papers 918, OECD Publishing.
    12. Claudio BorioBy & Piti Disyatat & Mikael Juselius, 2017. "Rethinking potential output: embedding information about the financial cycle," Oxford Economic Papers, Oxford University Press, vol. 69(3), pages 655-677.
    13. 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.
    14. Llaudes, Ricardo, 2005. "The Phillips curve and long-term unemployment," Working Paper Series 441, European Central Bank.
    15. Jósef Sigurdsson, 2011. "Unemployment Dynamics and Cyclical Fluctuations in the Icelandic Labour Market," Economics wp56, Department of Economics, Central bank of Iceland.
    16. 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.
    17. Laurence M. Ball, 2009. "Hysteresis in Unemployment: Old and New Evidence," NBER Working Papers 14818, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Afful, Efua Amoonua, 2014. "Does Employment Protection Legislation Induce Structural Unemployment? Evidence from 15 OECD Countries," MPRA Paper 56875, University Library of Munich, Germany.
    2. Ágeir Daníelsson & Lúdvík Elíasson & Magnús F. Gudmundsson & Björn A. Hauksson & Ragnhildur Jónsdóttir & Thorvardur Tjörvi Ólafsson & Thórarinn G. Pétursson, 2006. "QMM A Quarterly Macroeconomic Model of the Icelandic Economy," Economics wp32, Department of Economics, Central bank of Iceland.

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