Hysteresis in unemployment? Evidence from linear and nonlinear unit root tests and tests with non-normal errors

Abstract

Hysteresis implies that shocks to unemployment have permanent effects. In this paper, we undertake a robust examination of the hysteresis hypothesis for 14 OECD countries by utilizing both linear and nonlinear unit root tests. After performing several linear unit root tests, we employ unit root tests with structural breaks and a Fourier test that allows for unknown breaks and nonlinear functional forms. To further examine the robustness of our findings, we additionally utilize tests that consider non-normal errors. Testing is undertaken using quarterly data for the time period 1983Q1–2013Q3. Overall, we find support for unit root hysteresis in 4 of the 14 countries, the traditional natural rate hypothesis in 3 countries, and the structuralist hypothesis (a natural rate with structural breaks) in 7 countries. In sum, we find that shocks to unemployment have permanent effects in 11 of the 14 countries, while the permanent effects are most often infrequent.