MEAN REVERSION IN UNEMPLOYMENT: NEW FINDINGS FROM THE BALTIC TIGERS

Fumitaka Furuoka

doi:10.3846/20294913.2015.1070769

Abstract

The tendency of the unemployment rate to revert to the mean value or the natural rate of unemployment has been one of the most discussed topics in macroeconomics. This study focused on three Baltic countries – Estonia, Latvia and Lithuania – as case studies to investigate unemployment dynamics. Three unit root tests were performed for this purpose: 1) the Augmented DickeyFuller (ADF) test, 2) the Seemingly Unrelated Regressions Augmented Dickey-Fuller (SURADF) test and 3) the Fourier Augmented Dickey-Fuller (FADF) test. The null hypothesis was that unemployment in the Baltic countries is a unit root process. As the findings revealed, the ADF test and the SURADF test failed to reject the null hypothesis of a unit root for all the three Baltic countries. However, the nonlinear FADF test could not reject the null hypothesis for Lithuania. This means that unemployment in Lithuania could be described as a stationary process. As such, it has the tendency to revert to a sustainable level. By contrast, unemployment in Estonia and Latvia would be best characterised as a non-stationary process where the unemployment rate lacks the mean reverting behaviour.

Highlights

The tendency of the unemployment rate to revert to the natural rate of unemployment is one of the most discussed topics in macroeconomics
The findings of this study revealed that only in Lithuania unemployment could be described as a stationary process
The researchers argued that, without taking account of nonlinearity, the unemployment rates in all the three Baltic countries could be considered as a unit root process

Summary

Introduction

The tendency of the unemployment rate to revert to the natural rate of unemployment is one of the most discussed topics in macroeconomics. Studies on the behaviour of the unemployment rate become especially relevant during an economic crisis or in the post-crisis period. The present article focuses on three Baltic countries – Estonia, Latvia and Lithuania – and examines the mean reversion property in their unemployment rates. After peaking at 18.7 percent in 2010, the average unemployment rate began to decrease and diminished to 14.7 percent in the following year (Eurostat 2012). The newly developed FADF test produces better results in studies on the nonlinear behaviour of the unemployment rates.

Background of the study: the Baltic Miracle

Literature review

Methodology and empirical results

Findings

Conclusions