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Analyzing State Equilibrium Unemployment Rates. Persistence of unemployment rates. Comparing unemployment rates among states.
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Comparing unemployment rates among states • Comparing unemployment rates among states is difficult as the rate in a particular year may be heavily influenced by the state’s sensitivity to the national business cycle. Unemployment due to the business cycle is thought to be a disequilibrium event. • One approach to overcome this is to determine a state’s equilibrium unemployment rate, then use this equilibrium rate to compare states. • The point is to determine and explain what differences remain among states after business cycle effects are ruled out.
Determining the equilibrium unemployment rate • An equilibrium unemployment rate implies that the unemployment rate is constant from year to year. • This means that Ut=Ut-1=U* where ‘U*’ is the equilibrium unemployment rate, t is the current year, and t-1 is the previous year.
Determining the equilibrium unemployment rate • We can determine the relationship between Ut and Ut-1 . This will allow us to calculate the equilibrium unemployment rate. • Consider the equation Ut= α + βUt-1 + Error • The task is to: • Estimate the equation, • Substitute U* for Ut and Ut-1: U*= α + βU* • Solve for U* to get the equilibrium unemployment rate: • U* = α / (1- β)
Determining the equilibrium unemployment rate • For Tennessee: Ut = 0.9886 + 0.8623 Ut-1 • Setting Ut= Ut-1= U* : • U* = 0.9886 + 0.8623 U*. • Solving: U* = 0.9886/(1-0.8623) = 7.18%. • Since the equation is estimated using data from 1976-2011, we can call this the long-run equilibrium unemployment rate.
Determining the equilibrium unemployment rate • For the United States: Ut= 1.728+ 0.8204 Ut-1 • Setting Ut= Ut-1= U* : • U* = 1.728 + 0.8204 U*. • Solving: U* = 1.728 /(1-0.8204) = 6.53%. • The U.S. equilibrium unemployment rate is lower than that of Tennessee. Why?
Explaining differences in equilibrium unemployment rates • Reasons for differences in the equilibrium unemployment rate: • Compensating variations, • Structural characteristics, and • Wage rates.
Explaining differences in equilibrium unemployment rates • Compensating variations : favorable climate, local amenities, low crime rates, and recreational opportunities cause residents to accept a higher unemployment rate than otherwise would occur. Unemployed residents are less willing to move to other states for jobs and give up local advantages.
Explaining differences in equilibrium unemployment rates • Structural characteristics: workers who are highly educated are more able to move to other states for employment since demand for these workers is strong. Less educated workers with smaller incomes will have more difficulty paying all the costs of moving a household. These workers may also have more difficulty obtaining information about job opportunities.
Explaining differences in equilibrium unemployment rates • Wage rates: states that offer higher wages by industry also have higher equilibrium unemployment rates. Higher than average government transfer payments may also have an impact.
Explaining differences in equilibrium unemployment rates • Structural characteristics: research also shows that workers who are home owners and those who have resided in a state for at least 5 years are less likely to move on.
