Natural‐Rate Theory and OECD Unemployment

Our mission is to examine from the perspective of the intertemporal-equilibrium models of endogenous natural-rate theory the huge swings in unemployment among the OECD countries in recent times. We first look at the huge rise in jobless rates between the early 1970s and the early 1990s throughout the OECD: in the United States a rise from about 51 per cent to 7 per cent, Canada from about 6 to 10,Japan from 11 to 21, Italy from 31 to about 71, the United Kingdom from about 33 to about 9, France from about 23 to about 10, and West Germany from 4 to 5$;.1 We then look at the developing recovery of the general unemployment rate, most notably in the United Kingdom and the United States, amid a generally continued elevation of jobless rates among the less educated. We see the mid-1990s surge of unemployment in Germany, France and Italy as another story. There are other, older perspectives, of course. Keynesians interpreted events in the 1970s and in the 1980s as signs of effective-demand and effective-supply shocks (Feldstein, 1986; Fitoussi and Phelps, 1986; Malinvaud, 1985; Pissarides, 1990). But if the natural rate was unchanged they had to explain why the subsequent disinflation was short-lived (why inflation even turned up in the late 1980s or early 1990s) despite high unemployment. Lacking an endogenous natural rate, Keynesians could explain the durability of the slump only by positing either a permanent expectational disequilibrium or hysteresis, i.e. non-ergodicity (as in Phelps, 1972) or a degree of persistence so great as to be empirically indistinguishable from hysteresis. As the slump ran on, the expectational possibility wore thin. So they were down to hysteresis. Hicks (1974) launched a break with the Keynesian-monetarist perspective in the 1980s with his appeal to real frictions or rigidities. If wage-setting mechanisms make the real wage, v, sticky (in the sense of Lerner), hence predetermined in the short run, the unemployment rate, u, will rise in the short run in response to a shock contracting the 'demand wage,' i.e., a downward shift of the labour-demand schedule in the 1 u, v plane (Bruno and Sachs, 1985). Another landmark was a bargaining model with the property that its natural unemployment rate rose in response to several much-discussed shocks such as higher taxes and an energy shock reducing labour productivity (Layard and