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The Unnatural Rate of Unemployment: Reflections on the Barro-Gordon and Natural Rate Paradigms

Author

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  • Abhiruchi Rathi

    (Madras School of Economics, Chennai, India)

  • Naveen Srinivasan

    ((Corresponding author) Professor, Madras School of Economics, Chennai, India)

Abstract

Unemployment and inflation exhibit a positive correlation during the 1970s in the United States. Ireland (1999) uses the time-inconsistency framework to study long and short run dynamics between the two rates. However, for the long-run, we find that the conditions for cointegration are not met whereas the short-run restrictions grounded in economic theory are strongly rejected. We look at the moving natural rate theory for an alternative explanation of the abnormal behavior of inflation and unemployment. We employ a structural vector autoregression (SVAR) model to study the impact of shocks to natural rate on the two series. We use the Beveridge-Nelson decomposition to extract short-run natural rate estimates from the unemployment series. Further, we identify factors affecting the short-run natural rate using regressions. We conclude that changes in labor-market institutions like unemployment benefits, labor productivity and real wages, as well as changes in labor force growth and real interest rates explain significant variation in the estimated natural rate of unemployment

Suggested Citation

  • Abhiruchi Rathi & Naveen Srinivasan, 2020. "The Unnatural Rate of Unemployment: Reflections on the Barro-Gordon and Natural Rate Paradigms," Working Papers 2020-191, Madras School of Economics,Chennai,India.
    • Handle: RePEc:mad:wpaper:2020-191
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Phillips curve; Time-inconsistency; Natural rate; SVAR; Beveridge-Nelson decomposition; Labor-market institutions; IV estimation;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables

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