Hysteresis in Unemployment: Evidence from OECD Countries

The natural rate of unemployment is the equilibrium unemployment rate. If the actual unemployment rate does not fluctuate around some "natural" rate, it is implied that the unemployment rate may follow a non-stationary process. Existing studies using the conventional ADF unit-root test generally fail to reject the null hypothesis of a unit root in the unemployment rate. These findings have been interpreted as providing support for the hysteresis hypothesis. In this paper, we analyze a panel of unemployment rate series of OECD countries by employing a more powerful test which exploits the cross-section variations in the constituent series. An important issue that we consider concerns the appropriate critical values for the panel data unit-root test in the presence of serial correlation and contemporaneous correlation. The critical values are computed from bootstrapping simulations. We support the hysteresis hypothesis of the unemployment rate series of OECD countries.