Monday, June 20, 2011

How Much Cyclical vs. Structural Unemployment?

This is a question that has raged in the blogosphere for some time now.  And here is an answer from Prakash Loungani et al. (2011):
We provide cross-country evidence on the relative importance of cyclical and structural factors in explaining unemployment, including the sharp rise in U.S. long-term unemployment during the Great Recession of 2007-09. About 75% of the forecast error variance of unemployment is accounted for by cyclical factors-real GDP changes (Okun‘s Law), monetary and fiscal policies, and the uncertainty effects emphasized by Bloom (2009). Structural factors, which we measure using the dispersion of industry-level stock returns, account for the remaining 25 percent. For U.S. long-term unemployment the split between cyclical and structural factors is closer to 60-40, including during the Great Recession.
This is a little less than Scott Sumner's 70-30 split, but is still far more weighted toward cyclical factors than Arnold Kling's Recalculation theory suggests.  Tyler Cowen will also appreciate the light this study sheds on his questions regarding the relative importance of aggregate demand and aggregate supply shocks.


  1. Well, structural--I find in periods of strong demand, people go to OTJ training.

    Also, if construction is very strong, they seem to be able to take any willing and earnest guy and make him into a construction worker.

    The National Federation of Independent Businesses keeps saying, "it is the demand, stupid."

    If I have heavy orders, I will hire.

  2. So we had a construction boom that proved unsustainable. When house prices fell, construction fell. Less houses built, this is going to have a cascading effect through all the intersectoral linkages - lawn guys, granite counter tops, furniture, plywood, cement and so on ad infinitum. Banks find themselves with worthless securities, cut back on lending.
    Is this an aggregate demand problem (cyclical) or is it structural ? To me it looks like a whole array of relative prices are thrown out of kilter because of falsified expectations and it is going to take some considerable time to restore equilibrium. And because of that, hysteresis effects will build too.
    Once again, take to heart Hayek's dictum, which is an admonishment to the Keynesians, including the Friedmanian version of Keynes that your blog likes so much:
    Mr Keynes aggregates conceal the fundamental mechanisms at work.

  3. For completeness, I should add that Hayek's dictum applies equally to the real business cycle theory which is similarly overly aggregated (one sector!)
    But Long and Plosser did offer us a way out with their multisector version of a real business cycle theory and it still looks to me to offer the core for the future of macro, suitably fitted out with a financial sector of course.

  4. ECB,

    In my post I link to above, I show that the drop in construction was handled just fine from from April, 2006 to about mid-2008. Overall employment less construction employment was still growing during this time--other sectors were adjusting and absorbing the displaced workers from construction. If, as you claim, the intertemporal cascading effects were because of the decline in construction, then why did total employment keep growing through mid-2008? It is hard to reconcile your interpretation of events with the data.

    Something else had to have happened in mid-2008. My story is that monetary policy passively tightened. It fits the data well.

  5. Could be oil right ? I think Jim Hamilton has a paper showing that the oil shock of 08 can successfully explain the deepening of the recession.

    Oil shocks also have sectoral effects, as Hamilton showed in his 1988 JPE paper.
    Bottom line: I really don't like sticky price aggregate demand stories at all. My inner microeconomist makes me shudder - they don't make any sense to me. I can see how monetary policy can have effects through the financial intermediation channel - but Keynes/Friedman stories - I'm not buying.

  6. Beckworth, Being in new home construction at the time, I can tell you that there was no indication that anything was wrong. The home builders were building spec homes for even a few months after the lending dried up bc they didnt want to be stuck sitting on half finished houses. In my opinion and recollection most of the upper management were mostly concerned deadlines etc, and they really had no idea that funding would soon come to a screeching halt.