Re-examining the Structural and the Persistence Approach

This paper uses an unobserved component model to examine the relative importance of the structural and the persistence approach to unemployment. We derive the NAIRU from a standard imperfect competition model. The price- and wage-setting schedules include a measure for unemployment persistence. Short-run dynamics are introduced through a demand equation which is linked to unemployment via Okun’s Law. This multivariate model is then estimated for the US and the euro data using Bayesian techniques and the Kalman filter. The results show that although cyclical shocks are very persistent, most of the increase in European unemployment is driven by supply factors. The degree of persistence is somewhat lower in the US but demand shocks seem to be more important in explaining variation of unemployment