On the Non-Inflationary effects of Long-Term Unemployment Reductions

Abstract

The paper critically examines the New Keynesian explanation of hysteresis based on the role of long-term unemployment. We first examine its analytical foundations, according to which rehiring long-term unemployed individuals would not be possible without accelerating inflation. Then we empirically assess its validity along two lines of inquiry. First, we investigate the reversibility of long-term unemployment. Then we focus on episodes of sustained long-term unemployment reductions to check for inflationary effects. Specifically, in a panel of 25 OECD countries (from 1983 to 2016), we verify by means of local projections whether they are associated with inflationary pressures in a subsequent five-year window. Two main results emerge: i) the evolution of the long-term unemployment rate is almost completely synchronous with the dynamics of the total unemployment rate, both during downswings and upswings; ii) we do not find indications of accelerating or persistently higher inflation during and after episodes of strong declines in the long-term unemployment rate, even when they occur in country-years in which the actual unemployment rate was estimated to be below a conventionally estimated Non-Accelerating Inflation Rate of Unemployment (NAIRU). Our results call into question the role of long-term unemployment in causing hysteresis and provide support to policy implications that are at variance with the conventional wisdom that regards the NAIRU as an inflationary barrier.

Permanent scars: The effects of wages on productivity

“…46 In the 2008-2009 crisis, the increase in permanent job losses was significantly greater than the increase in temporary layoffs, causing a sharp reduction of the indicator; the opposite of what happened, for example, in the deep recession of 1975 (see Figure 4). 47 As our second indicator of labor weakness, we take the cumulated growth of the long-term unemployment rate, defined as the ratio between the number of people unemployed for 27 weeks or more and the labor force (for the advantages of using this indicator instead of the incidence of long-term unemployment see Paternesi Meloni et al, 2021). Looking at the number of unemployed by duration, we see that once again the 2009 crisis differs from the past in that the increase in the number of unemployed seems to involve mainly an increase in long-term unemployment (see Figure 5).…”

Permanent Scars: The Effects of Wages on Productivity

“…40 In the 2008-2009 crisis, the increase in permanent job losses was significantly greater than the increase in temporary layoffs, causing a sharp reduction of the indicator; the opposite of what happened, for example, in the deep recession of 1975 (see Figure 4). As our second indicator of labor weakness, we take the cumulated growth of the long-term unemployment rate, defined as the ratio between the number of people unemployed for 27 weeks or more and the labor force (for the advantages of using this indicator instead of the incidence of long-term unemployment see Paternesi Meloni et al, 2021). Looking at the number of unemployed by duration, we see that once again the 2009 crisis differs from the past in that the increase in the number of unemployed seems to involve mainly an increase in long-term unemployment (see Figure 5).…”