What Determines Unemployment in the Long Run? Band Spectrum Regression on Ten Countries 1913-2016

The rise in unemployment since the 1980s has been predominantly understood as driven by short-term shocks, or rigid labor market institutions. Aggregate demand is usually assumed to have no long-run impact on unemployment, but recent contributions call this into question. This paper adopts a long-run view of macroeconomic history to explore the relationship between unemployment and macroeconomic variables. We use wavelet analysis to decompose time series covering ten countries 1913-2016, into short, medium-, and long-run variations, and band spectrum regressions on the relation between unemployment, GDP, investment, interest rates and productivity. Through cross-country regression models, we find strong indications that unemployment correlates negatively with the long-run components of investment. Our results indicate that short- to long-run components of capital formation explain between 40 percent and 81 percent of variations in unemployment. Our results support the view that modeling and labor market policy should take long-run investment conditions into account