This paper develops a model of unemployment rate dynamics that provides an explanation of persistent cyclical unemployment that does not involve persistent expectational errors or other nonoptimizing behavior. Our results are based on the interaction of search dynamics and inventory adjustments. An important element in these dynamics appears to be heterogeneity in the labor force which can be characterized as consisting of a relatively small group of high turnover individuals who comprise the bulk of normal unemployment and a larger group of low turnover individuals who dominate movements in cyclical unemployment. Our empirical results provide support for this theory as we demonstrate that the appropriately measured probability of becoming employed during a recovery falls relative to normal because of the unusually high proportion of low turnover individuals who have lost "permanent" jobs. As a result, recovery is much slower than is indicated by normal relationships although each individual is searching optimally.Macroeconomists typically build models of the determination of real output with unemployment-rate movements explained, if at all, by an appended Okun's Law relationship. En this paper we show that this approach is misleading because it misses important sources of persistence in cyclical unemployment --and hence -real output. In particular, we show that unemployment-rate dynamics imply "humped-shaped" cyclical unemployment characterized by persistence even though unemployed workers have faulty information on wage rates for only a comparatively brief period of time. This result is based on the interaction of two stock or state variablesinventories and cyclically unemployed workers --which result in a brief *The authors acknowledge helpful comments from

This paper develops a framework for analyzing unemployment in terms of variations in the nt.imber and distribution of people becoming unemployed and in individual probabilities of leaving unemployment. Contrary to the emphasis on exit probabilities in the recent macroeconomics literature, we present empirical evidence in support of the proposition that changes in the size and distribution of the inflow Into unemployment are the primary determinant of the unemployment rate. Instead of falling at the beginning of a recession, the outflow rate rises (with a lag) in response to the increased inflows which drive the recession. In contrast to normal unemployment, cyclical unemployment is concentrated in groups with low normal exit probabilities; so the observed procyclical variation in the average exit probability may largely he explained by predictable distributional effects. To understand changes in the unemployment rate, should we concentrate on the factors that determine inflows into unemployment or outflows from it? Or, are both flow concepts statistical ephemera without any substantial use? This paper attempts to answer those questions and does so in a surprising way: The main proximate determinant of changes in the unemployment rate is variations in the level and distribution of inflows into unemployment. Since the probability of leaving unemployment is primarily determined by the characteristics of those becoming unemployed and is little affected by the business cycle, outflows from unemployment and hence the actual changes in the unemployment rate are primarily determined by the inflows. Instead, we contend that increases in the unemployment rate primarily reflect more people passing through that state, not each individual spending an 'For monthly observations, we have from definitions iU -wwhere y is the growth rate of the labor force. Since ru is negligible in magnitude relative to 4r-w, we have that the cumulative change in u over a quarter will Indeed equal 3 times the average values of -w over the quarter. Measurement of these variables is discussed below. In our (1985) paper we developed data which showed that the average probability of leaving unemployment does fall during recessions. In this paper, we extend our heterogeneity hypothesis which relates these changes in average probability to the much larger representation of slow searchers in cyclical as opposed to normal unemployment. We demonstrate in this paper that taking into account these distributional effects on average probabilities tends to strengthen the result that it is the level and distribution of the inflows that dominates movements in unemployment.A useful analogy which clarifies our viewpoint is to think of the number of people traveling by air at a given moment. At major holidays, this number rises both because more people are making trips and their trips cover longer distances on average. While there may be some increase in the time required to make a certain trip, this is secondary to the number and type of trips as a deter...

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X Conclusion iii ©International Monetary Fund. Not for Redistribution iv ii assesement of key features by anthiritites ss in countries iii summmary of key features of -prgf-supportedd programs iv prgf and esaaf staFff reports and other documenbts ents for the revieww woth prgf arrangemnets ©International Monetary Fund. Not for Redistribution II A.4. Authorities' Responses to Questionnaire on