Re-examining the Structural and the Persistence Approach to Unemployment

This paper examines the relative importance of the structural and the persistence approach to unemployment. We set out a standard imperfect competition model that decomposes observed unemployment into a structural and a persistent cyclical component. The natural rate of unemployment is treated as an unobserved variable that has observable effects on the measured unemployment rate, output and prices. The multivariate unobserved component model is estimated for the US and the euro area 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 structural factors. The degree of persistence is somewhat lower in the US but demand shocks seem to be more important in explaining variation of unemployment.