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The macroeconomics of the labor market: three fundamental views

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Abstract

We distinguish and assess three fundamental views of the labor market regarding the movements in unemployment: (1) the frictionless equilibrium view; (2) the chain reaction theory, or prolonged adjustment view; and (3) the hysteresis view. While the frictionless view implies a clear compartmentalization between the short- and long-run, the hysteresis view implies that all the short-run fluctuations automatically turn into long-run changes in the unemployment rate. We assert the problems faced by these conceptions in explaining the diversity of labor market experiences across the OECD labor markets. We argue that the prolonged adjustment view can overcome these problems since it implies that the short, medium, and long-runs are interrelated, merging with one another along an intertemporal continuum.

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Notes

  1. Prominent developments within this view are those that focus on the role of shocks and institutions (see, among others, Layard et al. 1991; Blanchard and Wolfers 2000), on the structuralist theory of unemployment (see, for example, Phelps 1994; Phelps and Zoega 2001), or have a purely institutionalist focus (e.g., Nickell et al. 2005). See Blanchard (2006) for a review and an appraisal of this literature.

  2. The CRT was developed by Karanassou and Snower (1996; Karanassou and Snower (1997; Karanassou and Snower (1998). See also Karanassou et al. (2003, 2004, 2006).

  3. See the influential contribution of Blanchard and Summers (1986) and Raurich et al. (2006) for a recent work in this area.

  4. See Henry et al. (2000), Karanassou and Snower (2004), Bande and Karanassou (2006), and Karanassou et al. (2006).

  5. The EU comprises the following 15 countries: Austria, Belgium, Germany, Denmark, Finland, France, Greece, Ireland, Italy, Luxembourg, The Netherlands, Portugal, Spain, Sweden and UK.

  6. Before 1991 these data correspond to Western Germany; 1991 onwards to the unified Germany. The annual growth rate of employment in the 1990s corresponds to period 1992–2000.

  7. See, for example, the textbooks by Blanchard and Fischer (1989) and Romer (2006).

  8. See, for example, Phelps (1994) and Layard et al. (1991) for explanations along these lines.

  9. For instance, the major rises in European unemployment benefits occurred predominantly in the 1960s and early 1970s, and thus extremely long and powerful lagged responses are necessary to explain the rising unemployment since the 1980s on this basis. See, for example, Grubb (1994) and Lindbeck (1994).

  10. Labor market adjustment processes are diverse and with well-known microfoundations from the theoretical literature. There are, for example, (1) employment adjustments effects (see Nickell 1978; Berndt and Fuss 1986; Lindbeck and Snower 1988); (2) insider membership effects (see Blanchard and Summers 1986; Lindbeck and Snower 1987a; Lindbeck and Snower 1987b); (3) wage/price staggering (see Taylor 1979; Taylor 1980); (4) unemployment adjustment effects (see Layard and Bean 1989); and (5) labor force adjustment effects (see French 2005; Flodén 2006).

  11. In fact they may well be complementary (so that their joint effects are stronger than the sum of their individual effects) or substitutable (so that their joint effects are weaker).

  12. See Karanassou and Snower (1997) and Karanassou et al. (2006).

  13. Recall that, in addition to a static labor market model, the frictionless equilibrium view is also manifested in dynamic single-equation unemployment rate models.

  14. Since work is divided equally among all workers, an increase in aggregate employment N t means more work done by each worker.

  15. In much of the frictionless literature, the coefficients of the labor market equations are constrained so that the level of the capital stock cannot affect the long-run equilibrium unemployment rate (see Karanassou and Snower 2004). For our model, the relevant restrictions would be d k  = 0, i.e. either a k  = 0 or b = 0 or c f  = c e .

  16. Generally, the AR(1) model is dynamically stable when \(\left\vert \phi _{n}\right\vert <1\). However, it is plausible to assume that unemployment is positively autocorrelated.

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Acknowledgement

Hector Sala is grateful to the Spanish Ministry of Education and Science for financial support through grant SEJ2006-14849/ECON.

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Authors and Affiliations

  1. Department of Economics, Queen Mary, University of London, Mile End Road, London, E1 4NS, UK

    Marika Karanassou

  2. Departament d’Economia Aplicada, Universitat Autònoma de Barcelona, 08193, Bellaterra, Spain

    Hector Sala

  3. Iza, Bonn, Germany

    Marika Karanassou & Hector Sala

  4. Kiel Institute for the World Economy, Dusternbrooker Weg 120, 24105, Kiel, Germany

    Dennis J. Snower

  5. Christian-Albrechts-University of Kiel, Kiel, Germany

    Dennis J. Snower

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  1. Marika Karanassou
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  2. Hector Sala
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  3. Dennis J. Snower
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Correspondence to Marika Karanassou.

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Karanassou, M., Sala, H. & Snower, D.J. The macroeconomics of the labor market: three fundamental views. Port. Econ. J. 6, 151–180 (2007). https://doi.org/10.1007/s10258-007-0024-y

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  • DOI: https://doi.org/10.1007/s10258-007-0024-y

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