Unemployment hysteresis and the NAIRU: a ratchet model

Abstract

In the 1970s and 1980s the USA and European economies experienced unemployment rates that persistently drifted upwards. The present paper captures this phenomenon by a simple extension of the hysteresis approach to the natural rate hypothesis of unemployment using a ratchet model. The impact of peak unemployment levels on unemployment hysteresis is incorporated using a traditional ratchet model. The model is estimated for the USA economy for the period 1948 to 1998. The results indicate that the relationship approximates a full hysteresis effect for peak-to-peak unemployment levels.