Analysis of Hysteresis in Unemployment Rates with Structural Breaks: the Case of Selected European Countries

Abstract

In recent years, unemployment has become a major problem in many countries. The fluctuations of the unemployment rate as well as its persistence in some countries impose challenges to economic policy makers. In order to implement appropriate policy measures, it is necessary to know the exact character of the unemployment in the observed country – is it structural or cyclical. In the context of economic theory, it is important to examine which concept better represents the behaviour of the unemployment rates – the concept of the natural rate of unemployment or hysteresis hypothesis. The character of unemployment is also influenced by some characteristics of a country under consideration. Therefore, the article examines the presence of hysteresis in monthly unemployment rates from January 2000 to January 2013 in two groups of countries: the selected European OECD countries and selected Central and Eastern European countries in transition. The analysis was conducted by using univariate and panel unit root tests and the structural break analysis. Although the hysteresis hypothesis cannot be rejected for the majority of the countries, when using univariate and panel unit root tests, the results of the structural break analysis indicate that the hysteresis hypothesis can be rejected in the case of OECD countries. In other words, the natural rate of unemployment better represents the movement of unemployment rates in this group of countries in the overall period. On the other hand, the hysteresis hypothesis cannot be rejected in the case of countries in transition. The presence of hysteresis effects in the countries in transition indicates that the application of economic policy directed to the demand side of the economy might have positive effects on reduction of unemployment. In OECD countries it is necessary to implement the institutional measures which could affect the bargaining power of labour unions, unemployment benefits, labour market flexibility, and so on.

DOI: http://dx.doi.org/10.5755/j01.ee.25.4.5263