New Zealand Labour Market Dynamics: Pre- and Post-global Financial Crisis

Razzak, Weshah Working Paper New Zealand Labour Market Dynamics: Preand Postglobal Financial Crisis New Zealand Treasury Working Paper, No. 14/03 Provided in Cooperation with: The Treasury, New Zealand Government Suggested Citation: Razzak, Weshah (2014) : New Zealand Labour Market Dynamics: Preand Postglobal Financial Crisis, New Zealand Treasury Working Paper, No. 14/03, ISBN 978-0-478-42113-2, New Zealand Government, The Treasury, Wellington This Version is available at: https://hdl.handle.net/10419/205658 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis Weshah Razzak New Zealand Treasury Working Paper 14/03 February 2014 Treasury:2827857v2 NZ TREASURY WORKING PAPER 14/03 New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis MONTH / YEAR February 2014 AUTHOR Weshah Razzak Email Telephone [email protected] +64 4 8907285 ISBN (O NLINE ) 978-0-478-42113-2 URL Treasury website at February 2014: http://www.treasury.govt.nz/publications/research-policy/wp/2014/14-03 Persistent URL: http://purl.oclc.org/nzt/p-1629 ACKNOWLEDGEMENTS Thank you to Nick Carroll, Mario DiMaio, Grant Scobie, and Gerald Minnee for their comments. Also thank you to Linda Cameron, Brian Sliverstone and an anonymous referee for valuable comments NZ TREASURY New Zealand Treasury PO Box 3724 Wellington 6008 NEW ZEALAND Email Telephone Website [email protected] 64-4-472 2733 www.treasury.govt.nz DISCLAIMER The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author(s). They do not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government. The New Zealand Treasury and the New Zealand Government take no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. The paper is presented not as policy, but with a view to inform and stimulate wider debate. WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis i Abstract A persistent increase in the unemployment rate ignites speculations about whether the changes to unemployment are structural or cyclical. The New Zealand economy has been through major restructuring since the mid-1980s. The labour market’s institutional changes were the last in the sequence of these reforms. As reforms began to take effect and expectations adjusted, unemployment in New Zealand has declined steadily and persistently since 1993-1994. Along the way, however, transitory increases in unemployment occurred. Major increases occurred after the Asian financial crisis and the global financial crisis with similar dynamics. JEL CLASSIFICATION J60, C2, C3 KEYWORDS Natural Rate of Unemployment; Speed of adjustment of the New Zealand labour market; estimation WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis ii Executive Summary The New Zealand economy went through major restructuring, starting in the mid-1980s. As reforms began to take effect and expectations adjusted, unemployment in New Zealand has declined steadily and persistently since 1993-1994. Temporary changes in unemployment occur because of economic shocks, such as unanticipated monetary and fiscal policy shocks, productivity shocks, and financial crises, e.g., the Asian financial crisis and the recent global financial crisis. These events push the unemployment rate and its natural rate around, creating gaps between them and slowing the adjustment of the labour market to its natural rate. We estimate the natural rate of unemployment from the pools of workers who move in and out the labour force. Then we estimate the speed of adjustment of the observed unemployment rate to this natural rate over the period 19922012. There have been concerns about the increase in the unemployment rate after the global financial crisis. Important issues in analysing the recent increases in the unemployment rate are whether these increases are cyclical versus structural and the speed of adjustment of the unemployment rate to its natural rate (NRU). We consider these issues by estimating the NRU and the speed of adjustment. We use labour market gross flows and a modified the Beveridge curve to estimate the NRU. We provide different estimates of the speed of adjustment. We found that first, the estimated time series of the natural rate of unemployment (NRU) in New Zealand to be significantly lower than the actual unemployment rate over the sample 1992-2012. Over the past two decades, the average NRU is estimated to be 4.6 percent whereas the average unemployment rate is 6.2 percent. So on average, the observed unemployment rate has been mostly higher than our measured NRU. In December 2012, we estimate the NRU to be somewhere between 4 and 4.5 percent while the unemployment rate is still much higher. Second, both the unemployment rate and the estimated NRU are persistent. Third, the level of the NRU is affected by unanticipated monetary policy shocks and by unanticipated fiscal policy shocks. Unanticipated monetary and fiscal policy shocks and TFP shocks reduce the NRU. Unanticipated fiscal policy shocks are associated with lower NRU and they have significant effects. Total factor productivity (TFP) shocks have much larger effects on the NRU and they are more significant than policy shocks. Fourth, available proxy measures of labour market institutions such as the minimum wage and union density have no effects in general, but union density seems to be positively associated with the NRU. Fifth, typically the speed of adjustment is a measure between zero and 1. Our estimates are between 0.10 and 0.50. On that scale, the speed of adjustment of the unemployment rate to the NRU take between 2 and 10 quarters to be complete. Sixth, the speed of adjustment increases after major recessions. There was a transitory increase in the unemployment rate in the late 1990s and early 2000s after the Asian financial crisis and similarly after the recent global financial crisis. The speed of adjustment increased markedly after the slowdown in the late 1990s and increased even faster after the most recent recession in the aftermath of the global financial crisis. Seventh, the main components of the NRU are the job finding rate and the job separation rate (flows in and out of unemployment) indicate that the former is significantly more volatile than the latter. The latter is strongly negatively WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis iii correlated with GDP over the business cycle frequencies. It increases sharply in recessions, but the magnitudes of the increase vary from one recession to another. Eighth, the Beveridge curve, which describes a negative relationship between the vacancy rate and unemployment, is not sufficient to draw conclusions about the NRU. It requires an additional curve, i.e., the job creation curve (JCC), which summarizes the demand for new jobs by firms. The resulting estimate of the NRU using this method is in line with the initial estimates: between 3.5 and 4.5 percent in December 2012. WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis iv Table of Contents Abstract ............................................................................................................................... i Executive Summary ........................................................................................................... ii 1 Introduction ................................................................................................................. 1 2 Estimating the Natural Rate of Unemployment ....................................................... 3 3 The speed of adjustment of the labour market ........................................................ 5 4 Estimation ................................................................................................................... 8 5 The Beveridge curve and the NRU .......................................................................... 12 6 Conclusion ................................................................................................................ 15 References ....................................................................................................................... 16 Tables ............................................................................................................................... 20 Data Appendix .................................................................................................................. 36 WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 1 New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 1 Introduction A persistently high unemployment rate generates discussions and speculations that the increase in unemployment is structural and not cyclical, Diamond (2013). Typically, people do not worry about low unemployment, but that does not make it less structural. Structural unemployment refers to changes in demographics and sectoral shifts, which are persistent, and supply shocks, which are beyond the control of monetary and fiscal policies. Structural unemployment can also refer to changes in the composition of unemployment, i.e., change in the long-term unemployed or the demographic make-up of the unemployed (Lazear and Spletzer,2012). In search theory (Pissarides, 2000) unemployment is frictional, and results from mismatches between jobs and workers. In such models, the labour market is rarely in equilibrium. Looking closer at the New Zealand data, the average percentage of the long-term unemployed (for more than 53 weeks) to the total unemployed over the period from 1986 to 2012 is 3.6 percent. This rate has been falling steadily over the period from 1995 to 2012. In 2008, it hit its lowest value of less than 1 percent. Then it began to rise again in the aftermath of the global financial crisis and the subsequent global slowdown. It was 2.9 percent in 2012. However, the percentage of the unemployed between 27-52 weeks has remained stable with an average of 1.5 percent for the 25 years from 1986 to 2012 and only slightly increased after the global financial crisis. In New Zealand, unemployment has been declining steadily. Over the sample period 1992-2012, shocks and institutional changes affect the adjustment process by nudging the unemployment rate and its natural rate away from each other. The unemployment rate was in double digits in the early 1990s. The Employment Contracts Act was passed into law in 1991, which constituted a significant institutional change in the labour market. The average unemployment rate fell from 10.6 percent for the period from June 1991 to June 1993 to slightly above 7 percent for the period from September 1993 to September 2000, a three percentage point fall. The Employment Relations Act, Working for Families, and other changes in the labour laws were introduced in the late 2000s; the unemployment rate fell to 4.5 percent from December 2000 to September 2009, i.e., another three percentage point reduction. This steady and slow decline in the unemployment rate has the marks of a structural change in the economy. However, just like after the Asian financial crisis, there has been a transitory increase in the unemployment rate in the aftermath of the global financial crisis and the subsequent economic slowdown. The average unemployment rate from December 2009 to December 2012 was 6.67 percent. This recent fast increase in the unemployment rate is high in comparison with the slow WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 2 decline observed between 1992 and 2009. Reinhart and Rogoff (2009), and Jorda, Schularick and Taylor (2011) show that jumps in the unemployment rate is a typical cyclical fluctuation, which follow most financial crisis. The objective of this paper is to analyse the recent increases in the unemployment rate; examine whether these increases are cyclical versus structural, and estimate the speed of adjustment of the unemployment rate to its natural rate (NRU). We consider these issues by estimating the NRU and the speed of adjustment. We use labour market gross flows, Hall (2005) and Yashiv (2007); and a modified the Beveridge curve to estimate the NRU, Daly et al. (2012). We provide different estimates of the speed of adjustment. 1 The dynamic of the labour market, gross flows, and the Beveridge curve in New Zealand have been studied in the past by Chapple et al. (1996), Dutu et al. (2009), Griffiths (2013), Grimmond (1993), Silverstone and Bell (2011), Silverstone (2001, 2005), Silverstone et al. (1995), and Woolf (1989), and Craigie et al. (2012) among others. This paper compliments the above literature, but it differs in a few ways. It studies the effect of the recent global financial crisis, provides different methods of estimation, and modifies the Beveridge curve analysis along the lines suggested by Daly et al. (2012). There are eight main findings in this paper. First, the estimated time series of the NRU in New Zealand is significantly lower than the actual unemployment rate over the sample 1992-2012. Over the past two decades, the average NRU is estimated to be 4.6 percent whereas the average unemployment rate is 6.2 percent. So on average, the observed unemployment rate has been mostly higher than our measured NRU. In December 2012, we estimate the NRU to be somewhere between 4 and 4.5 percent while the unemployment rate is still much higher, which is consistent with Sliverstone and Bell (2011) finding. Second, both the unemployment rate and the estimated NRU are persistent. Third, the level of the NRU is affected by unanticipated monetary policy shocks and by unanticipated fiscal policy shocks. Unanticipated monetary and fiscal policy shocks and total factor productivity (TFP) shocks reduce the NRU. Unanticipated fiscal policy shocks are associated with lower NRU and they have significant effects. TFP shocks have much larger effects on the NRU and they are more significant than policy shocks. Fourth, available proxy measures of labour market institutions such as the minimum wage and union density have no effects in general, but union density seems to be positively associated with the NRU. Fifth, typically the speed of adjustment is a measure between zero and 1. Our estimates are between 0.10 and 0.50. On that scale, the speed of adjustment of the unemployment rate to the NRU take between 2 and 10 quarters to be complete. Sixth, the speed of adjustment increases after major recessions. There was a transitory increase in the unemployment rate in the late 1990s and early 2000s after the Asian financial crisis and similarly after the recent global financial crisis. The speed of adjustment increased markedly after the slowdown in the late 1990s and increased even faster after the most recent recession in the aftermath of the global financial crisis. Seventh, the main components of the NRU are the job finding rate and the job separation rate (flows in and out of unemployment) indicate that the former is significantly more volatile than the latter. The latter is strongly negatively correlated with GDP over the business cycle frequencies. It increases sharply in recessions, but the magnitudes of the 1 Note that the NRU is a different concept from the Non-Accelerating Inflation Rate of Unemployment (NAIRU). The latter defines equilibrium unemployment as the rate associated with a unique constant inflation rate. This definition is inconsistent with the long-run vertical Phillips curve, which implies no trade-off between inflation and unemployment in the long run (Friedman, 1968) and Phelps (1968). It follows that the natural rate implies that any inflation rate can be consistent with the equilibrium unemployment rate in the long run. WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 9 2009. We test for stability of the parameters using the Chow test and the likelihood ratio test. Identification For the system of equations, we also check whether the system is identifiable. The system of equation (9) and (10) satisfies the order condition, which is a necessary but not sufficient and the rank condition, which is a sufficient condition for identification. The system is over-identified. Single equation estimate of the speed of adjustment Table 2 reports two single-equation estimates of the speed of adjustment. Each equation has a different measure of the NRU, * 1t uand * 2t u, which are defined in equations (2) and (4). The results show that the speeds of adjustments are 0.09 and 0.1, respectively. The estimates are low. The parameters are stable as indicated by the tests for stability reported in table 2. Low speed of adjustment is defensible if the labour market is largely described by a search and matching type model and the stylized fact that we use estimates for the NRU, which are significantly far removed from observed unemployment. System of equation estimates Table 3 reports the estimates of the speed of adjustment using the system of equations above. The table has seven columns. The first column reports the coefficients. The next six columns are divided into two blocks, one for using * 1t uas a measure of the NRU and the other is for * 2t u. For each we report three regressions. The first column of the first block includes the shocks only. The second includes the shocks plus the minimum wage / average wage growth rate as a measure of institutions, and the third, includes the shocks, the minimum wage / average wage and the union density as another measure of institutions. The samples are different because the labour market institution variables are shorter than the rest of the data. The same is for the second block. The estimated speed of adjustment is still treated as a constant parameter. The estimates are nearly identical to those reported from the single-equation estimate. The unanticipated monetary and fiscal policy shocks are significant, but the latter is more so than the former. Unanticipated expansionary fiscal policy reduces the NRU. And TFP shocks have negative significant level effects (semi-elasticity) on the NRU in the long run. The increase in TFP reduces the NRU significantly. The minimum wage / average wage growth rate is insignificant in all regressions, but the growth rate of the density function increases the NRU. WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 10 State-space In addition to the stability tests we reported in table 2 earlier, we estimate the speed of adjustment as a state variable in a state-space form. We allow the speed of adjustment to be a state variable and a function of the shocks defined and the labour institution variables defined earlier. ttttt uuu   1 * (12) tttt      1 (13) ttt v 1   (14) Table 4 reports the estimated coefficients and figure 5 plots the smoothed time-varying estimate of the speed of adjustment. We report four estimates in table 4, which has two blocks: one is when the variances of the state variables are estimated from the data. The other is where we imposed small variances to smooth the data. Under each block we have two columns. One column without the labour institution variables and the other with them included because the labour market institution variables are shorter samples. The filtered estimates are less than 0.10, which are very consistent with our previous estimates. The smoothed estimates are interesting. First, they are higher than our previous point estimates; the final estimates are 0.44 and 0.50. Second, the speed of adjustment has been increasing over time. Third, unanticipated monetary policy shocks have negative effects on the speed of adjustment. These shocks reduce the NRU. Since the NRU is below the unemployment rate in New Zealand, these shocks increase the gap between the observed unemployment rate and the NRU, hence a slower speed of adjustment. Neither unanticipated fiscal policy shocks nor TFP shocks have any effect on the speed of adjustment. Fourth, the speed of adjustment increases after recessions. It increased after the Asian crisis in 1998 and increased even faster after the recent global financial crisis. This finding seems consistent with Schumpeter (1934). The idea is that adjustments speed-up after recessions (depressions). The fact that the Schumpeterian creativedestructive forces show up in faster adjustments is present in the data. Carroll et al. (2002) and Mills and Timmins (2004) provide empirical evidence of a rapid creationdestruction force in the New Zealand labour market. Also see McMillan (2004). Finally, none of the labour market institution variables is significant. The most plausible explanation for the lack of correlation is that the measures of institutions do not vary significantly over the sample, while unemployment does, thus the correlation is small. Figure 5 plots the smoothed estimates of the speed of adjustment as a state variable for the regressions which do not include the labour market institution variables. The top panel corresponds to the first estimate of the system where the variances of the state variables are estimated from the data. The bottom panel is a smoother estimate in which we imposed arbitrary values for the variances to be 0.001 and 0.07, respectively. To summarise, the estimates of the speed of adjustment varies across different methods of estimations and assumptions. The fixed-point estimate, where the estimator is a single equation or a system of equations, is very small, 0.10 (the speed of adjustment lies between zero and one). The state-space system estimate is larger in magnitude. The standard errors around the estimate are between 0.10 and 0.50. These estimates are WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 11 plausible because the speed of adjustment varies with the business cycle. They increase after recessions and the financial crisis, and decline during expansions. Job finding and job separation rates Before we turn our attention to the Beveridge curve we examine the relationships between the components of the NRU, namely the job finding rate and the job separation rate, see equation (4). The data are plotted in figures 6 to 15. Figure 16 plots the cyclical fluctuations (Band-Pass asymmetric filter, Christaino and Fitzgerald, 2003) of the job finding and the job separation rates. The former is pro-cyclical whereas the latter is strongly negatively correlated with the business cycle. The amplitudes of the cyclical fluctuations of the job separation rate are relatively higher than those of the job finding rate; even though the job finding rate is more volatile as shown earlier. Although the job separation rate increased sharply during the 1998 recession in the aftermath of the Asian financial crisis, it increased relatively less in the 2000-2001 recession and sharply after the most recent recession in 2010. The amplitude of the cycle in the recent recession is lower than the one after the Asian financial crisis. The job finding rate, however, is pro-cyclical with smaller amplitudes than the job separation rate. The evidence from the U.S. data are controversial. The prevailing orthodoxy is that unemployment increases sharply during recessions and the job separation rate drives that process, Blanchard and Diamond (1990). This has been challenged by Hall (2005) and Shimer (2007), who argued that the job finding rate over the business cycle is highly volatile whereas the job separation rate is less volatile or acyclical. Yashiv (2007), Fujita and Ramey (2009), and Elsby et al. (2009) provide evidence that the job separation rate is the driver of high unemployment. These plots seem consistent with the BlanchardDiamond (1990) view of the U.S. data that recessions are periods of sharp rise in unemployment. And they are also consistent with most recent findings that the job finding rate is pro-cyclical, see Hall (2005) and Shimer (2007), however, the job separation rate is not acyclical in New Zealand. Canova et al. (2013) argue, correctly, that the evidence above is based on unconditional correlation analysis, which makes the interpretation difficult. The response of the unemployment rate depends on the source of the shock. We examine the effects of the following shocks: the level of TFP, the two proxies for unanticipated demand shocks, the monetary policy shocks, and the fiscal policy shocks, as well as the two measures of the labour market institution, i.e., the growth rate of the minimum wage/average wage ratio and the growth rate of the union density. Table 5 and table 6 report regression results. Monetary and fiscal policy shocks do not affect the job finding rate. However, these shocks have significant effects on the job separation rate. In other words, policy shocks contribute more to job separation than job finding. Unanticipated expansionary policy shocks are aggregate demand shocks and they seem to reduce the job separation rate. This asymmetry is rather interesting even though it is only marginally significant, which should be tested further in future research. The question is why aggregate demand policies seem to be associated with job separation more than job finding. In both the job finding and job separation rate regressions, TFP shocks have very sizable coefficients that are statistically significant. WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 12 TFP reduces the job separation rate by more than increasing the job finding rate. Institutions are found to be statistically insignificant, hence not reported.10 5 The Beveridge curve and the NRU Brauer (2007) views the NRU as the average rate of unemployment that would prevail in the absence of business cycle fluctuations. It represents frictional or structural unemployment. Frictional unemployment reflects the time spent by the unemployed to search for a job whereas structural unemployment reflects mismatches between labour demand and the skills and geographical location of the unemployed. The empirical relationship between vacancies (on the vertical axis) and unemployment rate (the horizontal axis) is the Beveridg curve (BC). Empirical analysis of New Zealand BC is in, for example, Craigie at al. (2012), Razzak (2009), and Silverstone (2006). The position of the BC may indicate the state of the economy over the business cycle. For example, the unemployment rate increases and vacancies decline during recessions. The curve shifts and changes in the slope occur often, which complicate the picture. The further away the shift of the BC from the origin the less efficient the matching processes is because a certain level of vacancy would be associated with a high level of unemployment. Inefficient labour markets are believed to indicate mismatches between the unemployed workers and the available jobs. In addition to mismatches, factors that may shift the BC curve may include skill mismatches, changes in the labour force participation rate, the unemployment duration, and policy changes. Recent advances in this literature modify the theory of the BC. Daly et al. (2012) study that the BC. They provide a model, which essentially shows that the BC by itself does not determine an equilibrium combination of vacancies and unemployment. What is needed is another curve intersecting the BC in the same space. This curve is the job creation curve (JCC), which is determined by firms’ recruiting behaviours. Firms hire workers to produce output. They create vacancies up to a point where the expected value of a job match equals the expected search cost to fill the vacancy. The expected value of a job match is equal to the marginal product of labour. The expected search cost is a combination of the firm’s direct recruiting cost and the probability that a job is filled. The probability of filling a job increases with the unemployment rate. That implies that the JCC is upward sloping, which implies that firms create more job vacancies when unemployment is higher (we showed earlier that the speed of adjustment increased during recessions in New Zealand, especially after the most recent recession). The slope of the JCC depends on a number of variables, such as the job separation rate, the level of recruiting costs, and the value of jobs, which is reflected in labour productivity and the value of output. In general, the slope depends on the structure of the product and labour markets in which firms operate and the wage bargaining process. It may also depend on the interest rate. Factors that shift the JCC include changes in the expected 10 We experimented with the lags of the shocks. We added up to four lags (arbitrarily). None of the lags is found to be significant, except for the third lag of the unanticipated monetary shocks in the job finding equation. We also tried the U.S. output gap as a measure of global demand shocks, and the variance of the U.S. output gap as a proxy for uncertainty in the global economy. None is found to be significant. The statistical results are not reported. WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 13 value of jobs that are associated with changes in the marginal product of labour. In recession, the aggregate demand falls; this reduces the marginal product of labour, and in turn reduces the value of creating jobs. This causes the JCC to rotate down (to the right) resulting in a higher unemployment rate with no shifts in the BC. Thus, the measured unemployment rate increases without a change in the NRU. Another example for shifts in the JCC is when the firm search costs change. For example, if the probability of filling a vacancy falls because of rising mismatch, the JCC rotates down. To summarise, the equilibrium unemployment rate is determined jointly by the intersection of the BC and the JCC as in the following sketchy. Studying the BC alone is not sufficient to draw conclusions about the NRU. Consider a shift in the BC from BC to BC’ (upward shift). For a given JCC, this shifts the equilibrium from point (a) to point (b). The equilibrium unemployment rate increases by less than the outward shift in the curve because the JCC is positively slopped. And the extent of the change in the equilibrium unemployment rate depends on the steepness of the JCC (its slope). For the equilibrium unemployment rate to change by the same amount of the outward shift in the BC, the slope of the JCC must be flat, or must shift outward or downward as well, as in the movement from point (a) to (c). The insight is that the shift in the BC and by how much is insufficient to explain what causes the unemployment rate to change. Information about the job creation rate is needed, i.e., the demand of labour by the firm. Also, to distinguish what part of the increase in the unemployment reflects purely cyclical fluctuations in labour demand, and what parts are related to other transitory and permanent factors that cause a rise in the NRU, we have to understand what causes the shifts of the BC and JCC and the permanency of these shifts. Figure 17 plots the BC for New Zealand using the vacancy rate and the observed unemployment rate. Our vacancy rate data are derived from the ratio of job advertisements (ads) to the labour force. There are two data series for job ads, which vary in quality and have some sharp movements. The newspapers ad series is the longest. It is a monthly series from the 1990s. The other series is the Internet ads series, which is shorter from 2004 onwards. We use newspaper job ads data. Job Creation JCC JCC’ BC BC’ a b c Unemployment rate Vacancy rate WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 14 The BC shifts. Typically, a shift away from the origin implies less matching efficiency; however, Daly et al. (2012) argue that such a shift is hard to interpret for three reasons. First, the BC not only shifts but also tilts so that a horizontal shift is not uniform across all levels of the vacancy rate. Second, estimating real-time movements in the BC is difficult because the size of the implied shift depends heavily on the specific month or quarter chosen. These shifts vary, and recently observed points are near a very flat segment of the BC, which combines large changes in the unemployment rate with small changes in vacancy rates. Third, figure 18 shows that following a labour market shock, the movement of the unemployment-vacancy rate follows a counter-clockwise adjustment pattern. This pattern occurs because firms can adjust their targeted hiring rapidly when the labour market conditions improve, but the matching process that will effectively reduce unemployment lags behind the increase in labour demand, as shown by Blancahrd and Diamond (1989). Daly et al. (2012) explain that the unemployment-vacancy combinations observed in the aftermath of a recession may represent the labour market adjustment process back to a stable BC rather than an outward shift in the BC. It is important to note that changes in the estimates of NRU during the period 2009 and 2012, which we plotted in figure 1, are much smaller in magnitude than the shifts in the BC plotted in figure 17. Daly et al. (2012) provide a rudimentary estimate of the JCC and plot that against the observed BC to accurately assess the change in the NRU for the United States. They estimate a long-run JCC by regressing the vacancy rate on a constant term and the NRU. The latter is taken from the Congressional Budget Office. We do the same for New Zealand. Only estimates of the JCC from March 2004 to December 2012 using the vacancy rate t v,which is based on the newspapers ads only and our measure of the NRU, * 2 u, produce an upward slopping JCC. The estimated curve looks like this: t v = 0.096+ 0.032 * t u (0.3697) (0.1196) 2 R 0.27 The equation is estimated by OLS. Consistent standard errors are estimated using the Newey-West method. P values are in parentheses. The intercept is insignificant. The slope coefficient is only marginally significant. These estimates are obviously crude, but they are the only estimates for New Zealand. Figure 19 superimposes the estimated JCC curve above on the BC (the vacancy-unemployment space) for the period 2004 to 2012 (the JCC passes through the origin since the intercept in the regression above is statistically indifferent from zero).11 Each point represents the cyclical movements along a given BC. In other words, each point represents the cyclical fluctuations in labour demand for a given natural rate of unemployment. The solid upward line is the estimated relationship between the average level of vacancies and our estimate of the NRU, which is reported in the regression above. So, we can read the value of the NRU on the x-axis from a point where the BC and the JCC intersect, which is only in December 2008. At this point, the NRU is 3.56 percent, which is even smaller than the average values reported in table 1, and the vacancy rate is 11 The BC (the vacancy-unemployment rate) has an intercept 2.5 and a negative slope -0.34. Both are significant at the 95 percent level. WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 15 0.48 percent. The NRU in December 2012 is somewhere between 4 and 4.5 percent, which is not far from our previous average estimate of 4.6. However, the average unemployment rate is 6.2 percent indicating that the labour market is still far away from its natural rate. 6 Conclusion The stochastic process that has been driving the unemployment rate in New Zealand is best described by a persistent decline, which is a result of a product of structural and institutional reforms since the mid-1980s. While these forces have been working to lower the unemployment rate, various shocks nudged the process along the way and might have caused a few episodes of transitory, sometimes sharp, increases in unemployment, which might have delayed adjustments. The underlying natural rate of unemployment behaves similarly, yet it is estimated to be significantly lower than the unemployment rate. Our average estimate over the past two decades is about 4.5 percent compared with the unemployment rate’s average, which is 6.2 percent. The natural rate and its main components, the job finding rate and the job separation rate, are significantly affected by total factor productivity shocks but not by labour market institutions. TFP shocks lower the natural rate of unemployment by reducing the job separation rate by more than increasing the job finding rate over the business cycle. Unanticipated monetary and fiscal policy shocks also affect the job finding and separation rate in the same way. We may accept the stylized fact that the labour market adjustment has been incomplete over the past two decades, which is consistent with search theory (Pissarides, 2000). Our estimated speed of adjustment is a low of 0.10. The smoothed state-space estimate of the speed of adjustment noticeably increases after recessions. It increased during the recession in the aftermath of the Asian financial crisis, and increased by much more during the recent recession in the aftermath of the global financial crisis. These stylized facts are consistent with the Schumpeterian creative-destructive theory, and with New Zealand empirical evidence reported in Carroll et al. (2002), Mills and Timmins (2004), and McMillan (2004). Unanticipated monetary shocks reduce the speed of adjustment because they reduce the job separation rate over the cycle, which reduces the natural rate and increases the gap between the natural rate and unemployment rate. The fact that labour market institutions do not affect the speed of adjustment seems in consistent with Blancahrd and Wolfers (2000) and Phelps (1994), who argue that the speed of adjustment in the labour market is a function of institutions rather than shocks, but maybe because the data we have are badly measured, or maybe because they do not change significantly over the sample, thus the correlation with the speed of adjustment is weak. The two variables that represent the labour market institutions, i.e., the minimum wage / average wage ration and the union density, are not well measured (we converted annual data to quarterly data) and that they are shorter than the rest of the variables. We found no significant effects from these variables on the speed of adjustment. However, the latter is positively associated with the natural rate of unemployment. WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 16 References Barro, R. J. and D, Gordon, (1983), A Positive Theory of Monetary Policy in a Natural Rate Model, Journal of Political Economy, Vol.91, No.4, 589-610. Barro, R. J. and M. Rush, (1980), Unanticipated Money and Economic Activity, in: Rational Expectations and Economic Policy (Ed., Stanley Fischer) University of Chicago Press. Barro, R. J., (1977a), Unanticipated Money Growth and Unemployment in the United States, American Economic Review, 67, 101-115. Barro, R. 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WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 25 Figure 1 The unemployment rate and three estimates of the natural rate of unemployment WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 26 Figure 2 The autocorrelation function of the unempoyment rate March 1992 – December 2012 Autocorrelation Partial Correlation AC PAC Q-Stat Probability . |******* . |******* 1 0.944 0.944 77.642 0.000 . |******| . | . | 2 0.891 -0.009 147.59 0.000 . |******| .*| . | 3 0.820 -0.192 207.54 0.000 . |***** | . | . | 4 0.747 -0.065 257.90 0.000 . |***** | . | . | 5 0.676 0.006 299.69 0.000 . |**** | .*| . | 6 0.594 -0.142 332.39 0.000 . |**** | . | . | 7 0.522 0.023 357.93 0.000 . |*** | . | . | 8 0.451 0.002 377.24 0.000 . |*** | . | . | 9 0.383 -0.034 391.40 0.000 . |** | . | . | 10 0.325 0.019 401.70 0.000 . |** | . |*. | 11 0.278 0.087 409.37 0.000 . |** | . | . | 12 0.241 0.016 415.19 0.000 . |** | . | . | 13 0.215 0.048 419.90 0.000 . |*. | . | . | 14 0.195 0.016 423.84 0.000 . |*. | . | . | 15 0.182 0.006 427.32 0.000 Figure 3 The autcorrelation function of the natural rate of unemployment * 1 u March 1992 – December 2012 Autocorrelation Partial Correlation AC PAC Q-Stat Prob . |******| . |******| 1 0.801 0.801 55.886 0.000 . |******| . |** | 2 0.767 0.348 107.65 0.000 . |***** | . | . | 3 0.666 -0.042 147.22 0.000 . |**** | **| . | 4 0.532 -0.239 172.82 0.000 . |**** | . |*. | 5 0.501 0.137 195.79 0.000 . |*** | .*| . | 6 0.364 -0.141 208.07 0.000 . |** | . | . | 7 0.319 0.016 217.59 0.000 . |** | . | . | 8 0.241 -0.034 223.11 0.000 . |*. | . | . | 9 0.171 -0.004 225.93 0.000 . |*. | . | . | 10 0.127 -0.053 227.51 0.000 WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 27 Figure 4 The autocorrelation function of the natural rate of unemployment * 2 u March 1992 – December 2012 Autocorrelation Partial Correlation AC PAC Q-Stat Prob . |******| . |******| 1 0.810 0.810 57.098 0.000 . |******| . |** | 2 0.773 0.340 109.74 0.000 . |***** | . | . | 3 0.675 -0.045 150.38 0.000 . |**** | **| . | 4 0.545 -0.233 177.23 0.000 . |**** | . |*. | 5 0.518 0.159 201.80 0.000 . |*** | .*| . | 6 0.378 -0.174 215.02 0.000 . |** | . | . | 7 0.327 -0.005 225.03 0.000 . |** | . | . | 8 0.247 -0.031 230.82 0.000 . |*. | . | . | 9 0.183 0.048 234.06 0.000 . |*. | .*| . | 10 0.137 -0.076 235.88 0.000 . |*. | . | . | 11 0.088 0.049 236.64 0.000 . | . | . | . | 12 0.068 0.015 237.11 0.000 . |*. | . |*. | 13 0.082 0.170 237.78 0.000 . |*. | . | . | 14 0.086 0.007 238.54 0.000 . |*. | . | . | 15 0.088 -0.030 239.34 0.000 WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 28 Figure 5 The Smooth Estimates of the Speed of Adjustment using State-Space Variances Estimated from the Data Smoothed Speed of Adjustment State Estimate -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1994 1996 1998 2000 2002 2004 2006 2008 2010 201 2 Speed of Adjustment ± 2 RMSE Variance Imposed .0 .1 .2 .3 .4 .5 .6 .7 1994 1996 1998 2000 2002 2004 2006 2008 2010 201 2 Speed of Adjustment ± 2 RMSE Smoothed Speed of Adjustment State Estimate WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 29 Figure 6 Job Finding Rate and TFP Shocks 14 16 18 20 22 24 26 28 30 -3.24 -3.20 -3.16 -3.12 -3.08 -3.04 -3.0 0 Log TFP JFR Figure 7 Job Finding Rate and Unanticipated Monetary Policy Shocks 14 16 18 20 22 24 26 28 30 -2 -1 0 1 2 UMPS JFR WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 30 Figure 8 Job Finding Rate and Unanticipated Fiscal Policy Shocks 14 16 18 20 22 24 26 28 30 -.08 -.04 .00 .04 .08 .12 .1 6 UFPS JFR Figure 9 Job Finding Rate and the Growth Rate of Minimum Wage/Average Wage Ratio 14 16 18 20 22 24 26 28 30 -.04 -.03 -.02 -.01 .00 .01 .02 .03 .04 .0 5 Growth rate minimum wage / average wage ratio JFR WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 31 Figure 10 Job Finding Rate and the Growth Rate of Union Density 14 16 18 20 22 24 26 28 30 -.03 -.02 -.01 .00 .01 .02 .03 .0 4 Growth Union Density JFR Figure 11 Job Separation Rate and TFP Shocks 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 -3.24 -3.20 -3.16 -3.12 -3.08 -3.04 -3.00 Log TFP JSR WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 32 Figure 12 Job Separation Rate and Unanticipated Monetary Policy Shocks 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 -2 -1 0 1 2 UMPS JSR Figure 13 Job Separation Rate and Unanticipated Fiscal Policy Shocks 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 -.08 -.04 .00 .04 .08 .12 .1 6 UFPS JSR WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 33 Figure 14 Job Separation Rate and the Growth Rate Minimum Wage / Average Wage Ratio 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 -.04 -.03 -.02 -.01 .00 .01 .02 .03 .04 .0 5 Growth Minimum Wage / Avergae Wage Ratio JSR Figure 15 Job Separation Rate and the Growth Rate of Union Density 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 -.03 -.02 -.01 .00 .01 .02 .03 .0 4 Growth Rate Union Density JSR WP 14/03 | New Zealand Labour Market Dynamics: Preand Post-global Financial Crisis 34 Figure 16 Business Cycle Fluctuations of Job Finding and Separation Rates -.3 -.2 -.1 .0 .1 .2 .3 .4 92 94 96 98 00 02 04 06 08 10 12 GDP Job Finding Rate Job Separation Rate Figure 17 The Beveridge Curve