This paper proposes a theory in which the low-frequency movements in unemployment are explained by the low-frequency movements and the volatility of productivity growth. On the one hand, an increase in long-run productivity growth lowers long-run unemployment. On the other hand, a fall in the variance of productivity growth leads to a fall in long-run unemployment even when long-run productivity growth remains flat. The key mechanism that explains these relationships rests on the assumption that real wages, or more broadly real marginal costs, adjust more easily upward than downward.
A recent literature has highlighted the importance of real wage rigidities to explain labor market dynamics at business cycle frequencies. Shimer (2005), Hall (2005), Gertler and Trigari (2009) and Blanchard and Gali (2010) show that real wage rigidities are important to account for a number of stylized facts including the high volatility of employment and vacancies as well as the low volatility of real wages. This paper complements these studies by showing that real rigidities can also account for unemployment dynamics at low frequencies and therefore it offers a rationale for the empirical relationship between long-run unemployment, long-run productivity growth and its variance.
Our analysis is motivated by a number of empirical papers, including Bruno and Sachs (1985), Phelps (1994), Blanchard et al. (1995), Blanchard and Wolfers (2000), Staiger, Stock, and Watson (2001) and Pissarides and Vallanti (2007), which show time-series and cross-country evidence in favor of a negative relationship between unemployment and productivity growth at low frequencies. This literature is exemplified by Figure 1 which reports the trend in unemployment, the trend in productivity growth and the variance of productivity growth for a postwar sample of U.S. data. The time series plotted in the charts on the first row are obtained computing averages and variances over five-year rolling windows. The charts on the second row display similar objects obtained using the time-varying Vector AutoRegressive (VAR) model described in Section 3.
Two main features are evident. First, irrespective of the strategy used to look at the data over the long-run, the charts on the first column of Figure 1 confirm the negative relationship between long-run unemployment and long-run productivity growth documented in earlier contributions. Second, a probably less known, yet very interesting, feature of the data is the strong positive association between long-run unemployment and the variance of productivity growth, which is uncovered in the charts on the second column. The Great Moderation in the variance of productivity growth, for instance, coincides with a sharp fall in the unemployment trend.
CONTENTS
1 INTRODUCTION
2 THE MODEL
- 2.1 FLEXIBLE WAGES
2.2 DEFINITION OF UNEMPLOYMENT RATE
2.3 STICKY REAL WAGES
2.4 DOWNWARD REAL WAGE RIGIDITY
3 EVIDENCE FOR THE UNITED STATES
- 3.1 MEASURING UNEMPLOYMENT AND PRODUCTIVITY TRENDS
3.2 THE FIT OF THE LINEAR MODEL
3.3 CONTROLLING FOR DEMOGRAPHICS
3.4 THE FIT OF THE NONLINEAR MODEL
4 INTERNATIONAL EVIDENCE
5 CONCLUSION
REFERENCES
APPENDIX A
APPENDIX B
APPENDIX C
APPENDIX D
APPENDIX E
APPENDIX F
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Unemployment and Productivity in the Long Run: the Role of Macroeconomic Volatility
